The theory that a weakening currency boosts economic growth appears to be just that: a theory. India’s experience is a case in point.
The rupee has been among the worst performing currencies this year, depreciating by about 17 percent by Friday. But economists estimate that India’s gross domestic product (GDP) grew only 4.7 percent in the second quarter, down from rates of over 5 percent in the past.
Nor has the depreciating rupee helped the country’s trade and services balance – the gap between revenue from exports of goods and services and the import bill. Bloomberg’s Businessweek.com reported last week, though the rupee has been steadily weakening for two years, the decline in its value has not helped narrow India’s current-account deficit.
“Instead, the trade gap has just gotten bigger, hitting 9 percent of GDP in the first quarter,” the website said. It quoted Goldman Sachs economist Tushar Poddar saying: “The sustained and large depreciation of the rupee since mid-2011 does not appear to have had any near-term impact on the current account deficit.”
South Africa’s experience is another case in point. The rand has lost about 17 percent this year but growth forecasts have been continuously revised down. The Reserve Bank has cut its forecasts from 2.7 percent to 2.4 percent to 2 percent.
And, though exports are rising, imports are also growing. The latest data show exports rose 11 percent month on month in July, but imports rose more than 18 percent. And the cumulative trade deficit for the year is R89.37 billion compared with R59.02bn in the same period last year.
Emerging market currencies have been badly hit by the reversal of US monetary policy, which prompted money to flow out of their markets and return to the US. But their economies have not boomed. On the contrary, growth projections are falling like skittles.
On India, Reuters recently quoted BNP Paribas as saying: “The economy appears to be entering a tailspin as business confidence collapses under the weight of rapid rupee depreciation, rising energy costs, sharply tightening financial conditions and policy confusion.”
The Brazilian real has tumbled about 14 percent, while the Russian rouble has fallen 6 percent. Last month, Brazil reduced its GDP growth estimates for 2013 from 4 percent to 2.5 percent while Russia cut its forecast to 1.8 percent from 2.4 percent.
There are two reasons for policymakers to avoid supporting weak currency policies. The main one is that there is no way governments can buck the market. The US and China can try and possibly succeed for a while because of the strength of their economies. Moreover, China has almost limitless foreign reserves and the US dollar is the world’s reserve currency.
But smaller countries don’t stand a chance – not even an economy the size of Brazil. It was not able to hold off earlier currency inflows, when emerging markets were the flavour of the month.
Another reason to avoid a weaken-the-rand bandwagon is that policymakers should be careful what they wish for. A weak currency doesn’t just help exports – it also sends inflationary impulses coursing through the economy.
And inflation erodes real economic growth because it steals money out of people’s pockets. Moreover, export growth needs more than a competitive currency. It needs external demand and steady production – in other words, workers who work. It also needs sound logistics.
Unless producers can produce and get their goods to the ports, a weak currency can only be debilitating.