Impact of Exchange Rate Volatility on some Select Sectors

Empirical evidence on the effects of the exchange rate and exchange rate volatility
on trade in India from some recent research studies is at best ambiguous. In fact,
research results which find positive, negative or no effect of exchange rate
volatility on the volume of international trade are based on varied underlying
assumptions and only hold in certain cases.

However, there is some evidence that volatility in exchange rate has impact on
different sectors and firms at different levels. Dhasmana (2013) used the industryspecific real exchange indices to study the impact of real exchange rate changes on
the performance of Indian manufacturing firms from 2000 to 2012. The main
findings of the study are that real exchange rate changes affect firm-level
performance through the import cost channel but not the export competitiveness
channel in the short run. The fact that the import cost channel is dominant in the
short run indicates that episodes of real depreciation are likely to result in a
contraction in real output growth at least in the short run. This study also calculated
the elasticity of output growth with respect to real exchange rate for different
industries. A positive sign of elasticity of output indicates a decrease in output
growth in response to a real depreciation on account of increased cost of imported
inputs. The study observed that the chemicals industry has the highest elasticity of
output growth with respect to real exchange rate (a 1 per cent real depreciation
causing output growth to decline by 12.5 basis points for an average firm) while
the footwear industry has the smallest elasticity (0.38). The elasticity of output of
some other sectors as per the study were: rubber (9.8), textile (4.8), plastic (5.4),
and metal and metal products (5.1).

Movement in exchange rate has different impact on different sectors. High-importintensity sectors like petroleum products (86.2 per cent imported raw materials
consumed), and chemical and chemical products (77.4 per cent) are more impacted
by rupee depreciation as a weaker rupee increases the value of imported inputs.
Low-import intensity sectors remain in an advantageous position especially in
price-sensitive international markets. An RBI working paper (2014) titled Impact
of Real Exchange Rate Volatility on Use-Based Industrial Production in India
found that components of the index of industrial production (IIP) like the capital
goods, basic goods, and intermediate goods sectors are adversely affected by
significant movements in the 36 country REER. The impact of real exchange rate
volatility on the basic goods sector is small. Moreover, the consumer goods sector,
with items such as passenger cars, apparel, antibiotics and sugar having large
weights in the group, is also not much affected by REER volatility due to low
import content and production supported by sufficiency of domestic demand. On
the other hand, capital goods are dependent on imports and therefore are more
impacted by unexpected changes in both exchange rate and relative prices. Thus,
periodic review of the neutral (or equilibrium) REER is an imperative.