When Your Neighbour’s Currency Depreciates | 2018-09-21 | daily-sun.com

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When Your Neighbour’s Currency Depreciates

Dr. Mir Obaidur Rahman

    21 September, 2018 12:00 AM printer

When Your Neighbour’s
Currency Depreciates

Dr. Mir Obaidur Rahman

A currency depreciates when it loses its value in international transactions. Rupee, the Indian currency is showing weakness from May and Taka, the Bangladeshi currency is gaining its value. The depreciation is due to the untenable imbalance of demand and supply of one currency in terms of demand and supply of another currency that ultimately causes the depletion of foreign reserves for intervention by the central bank to prevent the slide. A satisfactory level of foreign reserves helps maintaining a sound exchange rate conducive to sound trade balance. The depletion of reserves may be due to the ‘non-necessary’ imports, higher world prices for major import items inelastic by nature and the overall bitter global trade environment. Foreign exchange reserves that peaked at $426 billion in mid-April, 2018 in India witnessed a steady decline when Reserve Bank of India intervened in the market to stem the declining Rupee beginning May, 2018. The current reserve is about $ 400 billion. The currency fell to its record low of $1 = Rs 73 during the first week of September, falling 11 per cent against the dollar. When rupee depreciates, Bangladeshi traders get more Indian currency in exchange, Indian products appear to be cheaper and Indian tourism industry flourishes. This is indeed the common perception but there are many hidden agenda in currency appreciation and depreciation that policy planners should consider for a realistic exchange rate.  

Appreciation or depreciation of nominal or bilateral exchange rate is a very important determinant in trade balance defined as the difference between export earnings and import payments. Exchange rate, the price of one currency in terms of another currency is quoted with reference to USD. The currency quotation in financial market is expressed in two ways; the direct or the American quote is in USD per unit of foreign currency and the indirect or the European quote is just the reciprocal of direct quote; per unit of USD and is quoted in foreign currency. Another exchange rate is the cross exchange rate; when exchange rates are quoted between two non-dollar currencies such as the exchange rate between Bangladeshi currency taka and Indian currency rupees. The real exchange rate that considers the Consumer Price Index [CPI] in both the countries also plays a pivotal role in trade balance equation. Given the same CPI in trading partners, Indian exports will be less expensive to American consumers when the Indian currency depreciates against USD and the product price is quoted in USD. It is important to set the cross exchange rate between two currencies to retain competitiveness in the international goods market when the partner’s currency depreciates.

Depreciation of a currency against one currency may not represent the depreciation en masse; indeed the currency may appreciate with reference to another currency. Dollar depreciation with euro does not indicate that dollar also depreciates with GBP [Great Britain Pound] or JY [Japanese Yen]. The depreciation of Indian currency against the USD does not indicate the depreciation against the Chinese Currency Yuan or depreciation against Bangladeshi currency Taka. Thus when we consider the trade balance of partner countries due to depreciation of partner’s currencies either on aggregate or bilateral basis, the deficit in aggregate trade balance of partners countries may improve though there may be deterioration in trade balance on a bilateral basis.

When the trading partner’s currency depreciates, two types of effects in trade balance are discernible. First, effects on trade competitiveness on exportable in the same export destination. Secondly, the positive or negative impacts due to depreciation on the trade balance. Both India and Bangladesh compete in readymade garments in Unites States, the depreciation of rupees would lower the price of Indian garments but the export of readymade garments from Bangladesh would suffer when prices are quoted in USD. The deficit in bilateral trade balance may be aggravated when we buy more cheap products from India, import non-essential items and spent lavishly in foreign tour.

The continuous deficit in trade balance with India poses a problem when depreciated Indian currency results in increased export competitiveness of India in market especially in apparel and garments in destination where Bangladesh also competes. The very skewed nature of trade with import payments constituting roughly 15 per cent of our total import payments and with less than 4 per cent of total export earnings, the imports may get a boost due to lower cost of imports aggravating the trade deficit. Empirical study suggests the sensitivity of exchange rate on the trade volume especially the negative relationships with exports and positive relationship with import. Bangladesh has historically trade deficit with India, against the import payments of over $6 billion, the export earnings is paltry; less than one billion. Bangladesh adjusts the deficit through the trade surplus from other countries such as United Sates and the European Union. Though the trade with India is duty free and quota-free, unfortunately India practises non-tariff barriers in products that enjoy comparative advantage such as raw jute and jute goods. The two main exportable items from Bangladesh – raw jute and jute goods – are facing anti-dumping and countervailing duty ranging from $ 6.30 to $ 351.72 per ton. The huge deficit may not be tenable in the long run and India as a super economic power should be more open with liberal trade policies for import from Bangladesh. Bangladesh may be given certain concessions in trade with the land locked seven sisters located in the north-eastern region to narrow down the deficit.

 

The writer is a Professor of Economics, United International University


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