No simple answers to our export decline

India’s exports have been falling in dollar terms for the 17 months in a row. What is causing this and what can be done about it? A debate on these issues, especially the role of the exchange rate and the RBI, has been raging in the media. Yet, some important points are missing in the discussion.

Falling exports can be attributed to weak global demand and hence beyond the control of Indian policy makers. A significant part of our exports consists of refined petro products, iron ore and minerals, whose prices have fallen sharply. Such exports may have actually risen in volume terms. But that is not the case for all exports. Also, countries such as Bangladesh and Vietnam have been able to increase their exports in dollar terms during the same period. So, we cannot put the blame entirely on deteriorating global demand or falling prices.

There are basically two schools of thought here. One emphasises the structural/institutional features of the economy to be primarily responsible while the other holds the exchange rate to be the villain. The RBI, not surprisingly, subscribes to the former school.

The RBI view is that we should focus on improving our economic fundamentals and maintaining macroeconomic stability and the trend exchange rate should be left to market forces.

For improving our international competitiveness, we need to remove infrastructural bottlenecks, enhance productivity and access to finance, increase domestic competition, keep inflation in check and improve the ease of doing business in India.

If one looks at the nominal exchange rate, over January 2015 to March 2016 (a substantial part of the period over which Indian exports have been falling) the rupee depreciated against the dollar 6.2 per cent, whereas the Chinese yuan fell by only 4.6 per cent. Thus, contrary to popular perception, the rupee, instead of appreciating, marginally depreciated against the yuan and yet our exports were falling. The currencies of some countries (South Africa, Brazil, Russia, Malaysia, Turkey, Canada, the Eurozone) depreciated by much more, relative to US dollar, while the exports of several of them declined.

The real exchange rate or REER (both the six-currency and the 36-currency variants) — which better captures the average price competitiveness of India’s exports relative to its competitors — has remained flat over the period of falling exports. All these imply that the exchange rate was not the primary reason for the fall in Indian exports.

People who hold the exchange rate primarily responsible refer to cross-country empirical studies which show that relative exchange rates (with suitable lags) matter for export performance.

Even if that is generally true, the fact that the real exchange rate has remained flat during the period of falling exports (and even more strikingly, had actually appreciated, in both nominal and real terms, during the preceding period of rising exports) means that, for the specific period and the Indian context under consideration, exchange rate was not the main factor.

In theory, other things remaining the same, currency depreciation should produce an effect on a country’s exports. However, even here, one needs to make a distinction between demand and supply constrained situations. Depreciation helps exports particularly when the binding constraint is weak external demand and lower dollar prices sufficiently increase demand for exports (high price elasticities of demand). The situation becomes different if there is a supply constraint (like in most agricultural products). In that case, when rupee falls but supply remains the same, Indian exports may rise temporarily as production is diverted from domestic market to export market (since exporting becomes more profitable relative to home sales).

But more exports will push up domestic rupee prices of exports and the initial gain in international price competitiveness will be neutralised by higher inflation. Removing supply constraints calls for other kinds of reforms — not exchange rate adjustment.

A country’s export performance also depends on the credit terms, brands, reputation about reliable product quality and maintenance of delivery schedules, quality of repair and servicing facilities (for consumer durables and machines), linkages with global supply chains, access to global marketing channels (often controlled by multinationals), trader networks (note the role of expatriate Chinese traders in expanding Chinese exports), membership of big preferential trading arrangements, labour market flexibility (in the face of sudden rise/fall in export demand), efficiency of storage and transportation facilities, trade facilitation at the customs, and so on.

Even if one accepts that the RBI should intervene to maintain a competitive exchange rate, the question is: How? Since we allow free movement of foreign capital into and out of India, there will be periods of sharp appreciation and depreciation. The best that the RBI can hope to do is to smoothen out excessive fluctuations around the trend, but it should not try to buck the trend.

The folly of trying to prevent a currency from falling in the face of big capital outflow, whatever the reason, has been amply demonstrated by the experience of countries such as Thailand during the East Asian financial crisis.

Maintaining an undervalued exchange rate, as Japan, Korea and China are alleged to have done (and some Indian commentators are urging India to do) to artificially create a competitive cost advantage, run a big trade surplus and accumulate foreign exchange reserves, has its costs. Devaluation, by raising prices of imported final goods and intermediate inputs, pushes up domestic prices. Thus, an undervalued exchange rate, in effect, taxes domestic consumers and subsidises domestic producers.

Also, while it benefits the domestic producers of import competing products, it penalises the firms that use the imported goods as inputs. (for example, higher price of steel would benefit Tata Steel but would hurt Tata Motors). Accumulating foreign exchange reserves by running a big trade surplus deprives the current generation of a higher level of consumption while the savings held in the form of US government securities earn a meagre 0.5 to 1 per cent interest rate.

The upshot is that, in addition to global demand and exchange rate, falling exports could be the result of factors specific to individual products and markets. This may also explain why exports from Bangladesh and Vietnam, whose commodity compositions, markets and integration with global supply chains are different from India’s, could be rising while Indian exports were falling.

For similar reasons, India’s service exports dipped at a much slower rate than goods exports. The causes of falling exports should be subjects for detailed product and market specific research. A general explanation such as global recession or overvalued currency is not enough.

The writer is a former professor of economics at IIM, Calcutta

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