Many magazines mention that βto improve exports, the central banks need to depreciate the currency.β
However, what does it mean and how do exports get a boost by depreciating the currency?
To understand how lowering the exchange rate of a currency affects exports of the country,
Let us understand through a storyβ¦.
Mr. A is a mango seller. His mangoes are amongst the best in the market. He sells them for Rs.1000/- per dozen. He also exports mangoes to Mr. M in USA.
Let us say the exchange rate is Rs.80/- to a dollar. In other words, it means that if Mr. M were to pay $1, he could buy Rs.80/- from a currency exchange.
So, if $1 gets him Rs.80/-, he would need $12.5 to buy Rs.1000/- (1000/80 = 12.5)
So, he first purchases Rs.1000/- by paying $12.5.
Then he pays the Rs.1000/- to Mr. A for a dozen mangoes.
Suddenly one day Mr. M stops purchasing mangoes from Mr. A. On enquiring, Mr. A find out that Mr. M is buying from another country as he is getting them for $10.
To sell at $10, it would mean that Mr. A would have to sell a dozen for Rs.800/-.
Mr. A realizes that it is impossible to sell at this price. Far from earning profits he would be making a huge loss.
Now Mr. A go to the union of mango sellers who send a representative to the government with a request that instead of selling Rs.1000/- for $12.5, they should make the rupee cheaper and sell Rs.1000/- for $10 only.
Since the representative is strong and since even exporters of other products had made similar requests, the government relents and makes the rupee cheaper such that Rs.1000/- would be sold for $10. So now for $10 Mr. M can once again buy Rs.1000/- or for $1 he can now buy 100 rupees.
Thus, the upwards movement from Rs.80/- to Rs.100/- is the lowering of value of the rupee because now $1 can fetch Rs.100/- instead of the Rs.80/- which was possible before the depreciation ( or value reduction)
Since, rupee depreciation brought the value of the Rs.1000/- down to $10 (which Mr. M was paying for mangoes in another country), he now restarts his business relationship with Mr. A.
Thus, by depreciating the rupee the Indian government helps exporters like Mr. A.