The “Magic Potion” of Currency Depreciation

What else do we do when the US dollar firms up across the board?

In past months, the US dollar has been going up from strength to strength on the international financial market. During the past three months, it jumped up by 11% against a basket of other widely used international currencies. Its rise was sustained even if one were to look at it over a longer period: during the last year, it strengthened against those very currencies by 22%, its highest rate of increase over past decades.

The reason for this situation is simple. The performance of economies such as those of Japan and Europe continue to remain in dire straits. On the ‘emerging markets’ side, economic growth has slowed down. China is struggling to prevent its growth rate slipping down. Brazil and Russia are heading for recession. Excluding the BRICS, other emerging economies have contributed the least during the last quarter of 2014 to global growth compared to their track record the past five years. In this environment, with an IMF projected growth rate of 3.6% in 2015 for America, this country stands out as an oasis of future promise for sustained growth. Markets are therefore backing up its currency and, hence, the international gathering strength of the US dollar this last year.

Quite another reason for the increasing international strength of the US dollar is the monetary policy signal its respected central bank, the Federal Reserve Bank (Fed), has been giving to market watchers. It will be recalled that in 2013, the Fed announced that it was intending to do away with its Quantitative Easing (QE) in the near term, that is, it was planning to discontinue injecting additional US dollars into the system by buying up US government and such other eligible bonds, a policy it had initiated sometime back to deal with the international financial and economic crisis which hit the world in 2007-08. Even before the Fed started taking action in consequence, dollars started flowing back to the US with investors making up their mind that they stand to improve their returns by holding dollar assets instead of assets in the currencies of other countries which were still easing their monetary policy (bringing down the rates of interest thereon). The effect was to reinforce confidence in the US dollar as against other currencies.

In the same vein, the Fed changed last week the wording it uses in its public communiqués to indicate that it was now contemplating to raise US dollar interest rates in the course of this year. This caused the strength of the US dollar to rebound. It may be recalled that most currencies, including the US dollar, have been paying near-zero interest rates to investors in those currencies. If the US was to go into more positive territory in this respect, that would make holding the US dollar even more attractive. As demand for the currency picks up in consequence, its exchange rate vis-à-vis other currencies follows the same direction. This is the context in which markets have been acting during the past three months, sending the US dollar to unprecedented heights.

The current situation means that if the US economy continued to be perceived as a key factor of sustained economic growth at the global level, it might go from strength to strength vis-à-vis other major world currencies. It is the safe haven status of the US currency plus the perception that its central bank means business which is making the US dollar go up against other currencies such as the euro, the pound Sterling, the Japanese yen and the Chinese yuan.

A country like Mauritius has a significant part of its import bill (notably for oil, food commodities, manufactured items, etc.) invoiced in US dollars. The rupee has been depreciated during the past three months by about 20% against the US dollar. A dollar that was costing us around Rs 30 at the beginning of this year now costs Rs 36. Since currency depreciation has to apply across the board and not selectively against individual currencies, the gains that would have been registered by the rupee against other non-dollar currencies dropping down against the US dollar in the process described above, have been lost. So, imports from other sources are also costing us more than what they would have cost us had there been no deliberate rupee depreciation. In a country like Mauritius, importers simply pass on the cost of currency depreciation to the public. This process has started already and will likely continue since we are now benchmarked to a rupee that has been deliberately weakened.

Should the US dollar keep strengthening, Mauritius would by the logic of the past three months allow the exchange rate of the rupee to follow suit by falling further. Such a situation will escalate the adverse impact on the people’s cost of living which has already been partly felt and still is in the pipeline from the fall of the rupee during the past three months.

The rupee depreciation is apparently intended to give exporters of goods and services additional rupees in their hands than what would have been the case had the rupee not been depreciated. Since time immemorial, irrespective of whether there is a strengthening of a particular currency (as now in the case of the US dollar over the last year) or it is plain sailing, the exporting sector has kept asking for the rupee to be depreciated. Mindful of the negative impact of such demands on the cost of living of the public, the central bank has usually stepped in to rein in the local financial market from yielding to such demands. It has not allowed one-sided arguments to pull the rupee down. It has restrained market forces, keeping in mind the negative impact of any such depreciation by the market would have on the public.

The problem has been that despite the rupee having been gradually pulled down in the process against major currencies over a span of a long number of years, our export sector has not managed to gain competitive edge on its export markets. This is evidenced by the fact that our overall export performance has been stagnating since many years, including the pre-international crisis years. This is what also explains the substantial trade deficit the country’s balance of payments has been recording year after year. Our export sector has not created the edge it was in need of to drive a higher amount and a more diverse range of exports onto external markets despite the extensive depreciation of the currency it has benefited from down the years.

There hasn’t been creativity and innovation enough to grow our exports to match at least the increasing value of our annual imports. The problem is deeper than merely one having to do with a misaligned exchange rate of the rupee vis-à-vis other currencies. As we did in the beginnings of the Export Processing Zones, we should have employed state-of-the-art international consultancies to breathe a new spurt of life in our export sector, to enable it scout for new resources and sustainable product markets to break the resistance to growth our export sector has been living with over so many years. We haven’t done that. We’ve chosen instead to give the “magic potion” of currency depreciation at great cost to the public from time to time. The time has come for our enterprises to truly embed themselves into a longer-term vision.

* Published in print edition on 3 April  2015