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Yuan devaluation: 5 reasons why India won't join currency war

Yuan will certainly have a negative impact on India's exports. There are some who are predicting a currency war, but RBI Governor Raghuram Rajan won't play ball.

twitter-logo Anand Adhikari        Last Updated: August 12, 2015  | 20:21 IST

Anand Adhikari, Deputy Editor, Business Today
China's surprise devaluation of yuan this week may give fresh ammunition to some experts in India who have been rooting for a weak rupee against the US dollar to boost the country's sagging exports.

A weak currency theory also gives a leg-up to the BJP-led NDA government's 'Make in India' initiative . There are also murmurs in the government supporting a weak rupee in order to be competitive in the world market. In May, Commerce Minister Nirmala Sitharaman minced no words when she said that a weaker rupee  will help exports.

At the time, the rupee was weakening from the 61-62 levels. Today, it has fallen below 64 against the dollar. The rupee has been weakening over the years. It has been falling since 2008 when it appreciated to 40 against the dollar. The Chinese devaluation, though marginal, has created a flutter globally. It will certainly have a negative impact on India's exports. There are some who are predicting a currency war, but RBI Governor Raghuram Rajan won't play ball.

Here is why India will maintain its exchange rate policy:

  1. High Inflation: India is battling high inflation, which has been a major roadblock in the way of growth. In fact, inflation has yet to reach a low and stable mode. The currency has a direct implication on inflation. A weak rupee will increase the cost of imports, especially the crude oil bill, which in turn will fuel inflation through fuel price hikes. India cannot afford to have a high inflation for a long period as it has both political and economic implications.
  2. Foreign capital flows: At a time when India is starved of domestic capital, foreign capital has been a saviour. In fact, India has been making all efforts to attract foreign capital. The new government has recently relaxed foreign capital limits in defence, railways, insurance etc. A weak rupee impacts their return on capital. For example, a lot of foreigners including private equity players invested in 2007-08 period when the rupee was 40 against the dollar. Today, the rupee is at 64, which  means a 40 per cent loss in terms of currency exchange. So they have to make supernormal profits to make money in India because of currency adjustment or pay a higher cost of hedging. So the top priority today is to attract foreign capital to support the growth momentum in the economy.
  3. High Cost Of Capital: Currency is just one element that influences cost favorably if it depreciates or is devalued. There are other bigger elements like the cost of capital. Indian companies are already under stress because of high cost of capital as compared to their global peers. Banks' base rate, which is the minimum lending rate, is over 10 per cent. Interest rates will come down if inflation softens and both are linked to currency also. The RBI governor has already indicated that a low and stable inflation is a prerequisite for lowering interest rates in the economy.
  4. Ease of doing business in India: India lacks infrastructure facilities, which makes doing business in India costlier. Unreliable power supply, too many regulations, archaic labour laws and the bureaucratic system all create hurdles for Indian entrepreneurs and exporters. The new government is  addressing these issues, but a lot needs to be done.
  5. Focus On Innovation: Indian doesn't export high-end sophisticated goods. In fact, Infosys founder NR Narayana Murthy had hit the nail on the head when he recently remarked that India hadn't done any earth-shattering innovation in the past 60 years. If India becomes a factory to the world, like China, a weak currency is definitely the answer. But letting the rupee fall to support a few products won't help boost India's exports.

 

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