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The upside of the falling rupee

How India is using the opportunities in a weak currency,in terms of import substitution and a spurt in exports.

How India is using the opportunities in a weak currency,in terms of import substitution and a spurt in exports.

A weak currency helps growth,and is in many ways equivalent to monetary easing. One recalls the fear of currency wars not long back: it seemed as if the developed countries were in a game of competitive currency devaluation in their desperation to get their economic vitality back. This view took a backseat when the reverse started to happen,and the currencies of developing economies went into a free-fall. In India,the precipitous decline of the rupee between May and August created panic,very similar to a run on a bank. But now that some stability has returned,we can evaluate the beneficial impact on the economy.

The opportunities clearly lie in import substitution and exports as local manufacturing costs fall with the rupee’s decline. To understand the substitution argument better,Credit Suisse research divided India’s import basket into four categories based on the reason for

importation: unavailability,incapability,lack of capacity and lack of cost competitiveness. Of these,Indian manufacturers were able to benefit from the weak currency only in the “lack of cost competitiveness” category.

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Unfortunately for India,the first three categories accounted for more than 85 per cent of imports last year. Imports of goods that the country just does not have,such as crude oil,gold,coking coal,copper and potassium fertiliser,were almost two-thirds of India’s import basket. Another 12 per cent were imports of goods that India cannot make,including cellphones,computers,aircraft and high-end cars. These categories of imports would only fall with a decline in prices,when local demand weakened,or regulators imposed restrictions (as they have done with gold). Due to lack of capacity,for example,in some types of chemicals,steel or automotive parts,were 12 per cent of the import basket. In some of these categories,such as steel,capacity growth is picking up,and substitution is happening,though at a slow pace.

The lack of cost competitiveness group was only 13 per cent of total imports last year,but at about $42 billion,it was not a small amount in absolute terms. Among other things,it included low-tech consumer appliances,some types of capital goods and pharmaceutical ingredients. Some of these sectors have already started to see substitution.

A much larger opportunity lies in exports: the higher the proportion of rupee-based costs for an exporter,the larger the advantage of a weak currency. For example,a copper smelter that imports copper concentrate and exports copper would not gain much,as it has 98 per cent of its costs in US dollars. On the other hand,as almost two-thirds of the costs in two-wheeler manufacturing are denominated in rupees,two-wheeler exports get a boost.


In fact,there are some exciting changes afoot in the automotive sector. Indian two-wheeler manufacturers are making deep inroads into the growing markets of Africa and Latin America. The currency of course helps,but they have also improved productivity substantially. It is remarkable that despite sharp increases in the prices of metals,rubber and labour over the last two decades,the rupee price of a motorcycle is pretty much what it was when I became capable of riding one in the mid-1990s,and yet the mileage,design and power are better than before.

Small-car manufacturing is a classic example of demand creating supply. Now that domestic car demand has reached a level that makes the market attractive for global automakers,most foreign brands have entered India. But with high imported content,the rupee’s weakness makes it difficult for them to compete against well-entrenched manufacturers that have high levels of indigenisation. The new entrants cannot indigenise more until they get sufficient scale locally: a chicken and egg situation. The solution is exports: an increasing number of car makers are making India a small-car export hub. A fifth of all small cars manufactured are already exported,and this proportion is likely to rise sharply in the coming years.

Take IT services: the salaries of entry-level Infosys engineers have been unchanged for six years. In US dollar terms,they are back to 2005 levels! There has been a sharp surge in the supply of engineers as intake capacity in colleges has more than doubled over the last six years. Some question the quality of this expanded cohort,but such cynicism ignores the fact that if quality was inversely proportional to the quantity of graduating engineers,it would have been falling steadily for two decades! The volume growth in IT may not just happen with Indian companies,but also with global firms increasing the size of their India operations.


The real surprise in India’s export story over the last few years has been agriculture. Agriculture exports have soared from $18 bn to $41 bn in three years. Many were surprised that India was the largest beef exporter in the world last year,and beef export volume is expected to rise another 20 per cent this year. The rise in wheat and rice exports is likely the result of rising production with stagnating demand. After all,with rising automation (people cycling instead of walking,using tractors,etc),the per capita consumption of cereals is falling in India but grain production keeps rising. The surplus rots in godowns until there is no other option but to export. From a purely economic perspective,the farmer is the strongest beneficiary of a weaker rupee,as his cost base is almost purely in rupees.

There are several categories of exports that should benefit as well,including textiles and bulk drugs. But these changes will only play out over a period of time: capital markets and exchange rates may move at the speed of thought,but the real business response to these changes is a lot slower. It could take several months,for example,for an exporter to expand capacity,get orders,manufacture and export.

In the last four decades,India’s exports have declined only in six years,and mostly after a global crisis. At 24 per cent of GDP,goods and services exports are now a meaningful part of India’s economy (for comparison,China is at 31 per cent). Even if they grow by 10 per cent,they can add up to 1 percentage point to reported GDP growth. We could thus see a growth surprise driven by exports,and the RBI,in its policy decisions,should already be factoring it in.

The writer is the India Equity Strategist for Credit Suisse

First published on: 04-10-2013 at 02:29:00 am
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