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IMF Study Links Currency Depreciation and Growth

Study of Developed and Emerging Markets Renews Importance of Currency Effect on Trade

Despite the theories about how trade has decoupled from foreign exchange, it seems that everybody loves a bargain; with global trade still following the traditional pattern of a rise in sales after a price cut. The International Monetary Fund (IMF) released a currency study as part of its World Economic Outlook that highlights the strong connection between a currency rate drop and a rise in exports. The study found that a 10 percent fall in the currency may spur average gross domestic product growth (GDP) by 1.5 percent.

The study took into account economic data from developed and emerging markets for over three decades.

Not all currency depreciations are created equal. The IMF found that currency moves that followed a banking crisis tended to have a lower positive effect on the country’s exports. The markets that have a slack in the domestic economy and stable financial systems have an advantage to benefit from a lower currency. The Indian rupee fits the pattern of the IMF’s study on how currency depreciation can lead to overall growth.

Indian Rupee Depreciation an Example of IMF’s Findings

The Indian rupee has depreciated 7.51 percent year over year and is down 15.61 percent since May, 2013 when the U.S. Federal Reserve announced its tapering program. Indian exports rose to 25.2 percent of GDP in 2013, the first year where depreciation hit and, according to the IMF analysis, when the gains will be more evident.

The rupee has followed macro-economic trends and has depreciated against the U.S. dollar as the American central bank has still within its sights the first rate hike in almost a decade. The fact that the Fed has not yet delivered the higher interest rate has put the pressure back on central bankers to steer their economies on the right path.

Reserve Bank of India Rate Cut to Boost Productivity

Reserve Bank of India (RBI) Governor Raghuram Rajan put forth further evidence that his status as an elite central banker is well deserved. The Indian central bank announced a rate cut to the benchmark interest rate to a four year low of 6.75 percent to boost the rate of growth of the Indian economy.

The move by the RBI was widely anticipated but Governor Rajan surprised the market by the size of the cut -50 basis points, instead of the expected 25. The size of the cut speaks volumes about the confidence of Mr. Rajan not only of the growth potential of the nation, but its ability to deal with inflationary pressures. Inflation forecasts remain low despite a monsoon shortfall and Mr. Rajan noted in the rate statement that the government’s supply-management policies have contained upward pressure from food items.

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