INR has depreciated by 7.3% against the USD over the last year.
Domestic currency depreciation is never good news for countries with trade deficits. A trade deficit indicates that a country is importing more than it is exporting.
India’s merchandise exports in June 2022 jumped 23.52% YoY to $40.13 billion, while imports increased 57.55% YoY to $66.31 billion. Thus, the country’s trade deficit ballooned to a record of $26.18 billion resulting in higher demand for the USD.
Since liberalization, INR has depreciated by 2-3% annually against the USD. This time, the sharper depreciation of INR has been aided by foreign investment outflows, higher crude oil prices, and increasing demand for imported goods.
Although, depreciating currency reduces the costs of exports making them more appealing if imports are higher than exports then the overall benefits from higher exports to a country are more than negated by the costs of higher imports.
India faced a sharp currency depreciation in 2013 and RBI had to take some drastic measures to arrest the decline. Fortunately, our fundamentals (especially forex reserves) are stronger now and hence we are better prepared to manage the forex situation.
Depreciation of currency adds to inflationary pressure in the country and makes the life of the Central Bank Governor more difficult.
To curb the spread of imported inflation to other goods and services in the country, RBI has to increase interest rates that impact overall demand. It is negative for the broader stock market index but few sectors benefit from it.
Sectors like IT, big Pharma, etc. that earn revenue through exports are major beneficiaries. On the contrary, sectors like FMCG, paints, oil refineries, etc. where major raw materials are imported see their margins squeezed and thus are negatively impacted.
However, investment opportunities in companies/sectors that benefit from exports need to also account for valuations for generating decent returns in the medium to long term.
Originally posted on LinkedIn: www.linkedin.com
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