There is often an underlying assumption that exchange rate depreciation is good for the economy. The examples of India and Brazil show that this is not the case, even for industry, as economists at Natixis note.
Key quotes
“It is widely believed that exchange rate depreciation stimulates growth. Sometimes a more elaborate view is expressed: that exchange rate depreciation is good for industry but is negative for consumers and for services, because of the deterioration in the terms of trade (the rise in the relative price of imports).”
“The depreciation of the rupee since 2012 has coincided with slowdowns in consumption and investment, credit, GDP and employment, industrial production, which is particularly troubling given the depreciation of the exchange rate and even exports.”
“The depreciation of the real since 2014 has led to exactly the same developments as those seen in India. Slowdown in consumption and investment, credit, GDP and employment, manufacturing production and exports.”
“Exchange rate depreciation negatively affects the economy via five mechanisms. Exchange rate depreciation leads to highly positive real interest rates, due to expectations of future depreciation and the monetary policy response. The high real interest rates explain the slowdown in credit and investment. Investment by foreign companies is deterred by the prospect of exchange rate depreciation. Imported inflation reduces consumers’ purchasing power. The rise in the prices of capital goods and imported commodities contribute to reducing investment and capital outflows reduce bank liquidity and the credit supply.”
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