An introduction to start export-import of your products with China

By Tejas Siddalingeshwar, Researcher, NITISARA

This article examines the fundamental relationship between currency fluctuation and export competitiveness, focusing on the paradoxical case of India. Despite the Indian Rupee’s sustained multi-decade depreciation—including a recent 12% drop—Indian merchandise exports have remained largely stagnant as a share of GDP. This study investigates the breakdown of traditional macroeconomic stabilizers, such as the Mundell-Fleming model and the Marshall-Lerner condition, within the Indian context. Key impediments identified include the Dominant Currency Paradigm (DCP), persistent inflation differentials affecting the Real Effective Exchange Rate (REER), and the high import intensity of Indian manufactured goods. Furthermore, the analysis highlights industrial growth gaps where India has lagged behind regional peers like Vietnam, Indonesia and Bangladesh. The article concludes with strategic recommendations for policy shifts away from nominal exchange rate management toward structural reforms, including deepening domestic value chains, strict inflation targeting during external crisis, and internationalizing the Rupee to enhance long-term export resilience.

Theoretical Foundations of Exchange Rates and Trade Balances

Traditional theory suggests that depreciation enhances trade balances through expenditure switching. This rests on the Mundell-Fleming model, the Marshall-Lerner Condition, and the J-Curve Effect, assuming that a weaker currency makes exports cheaper and imports costlier.

The Mundell-Fleming Framework and Expenditure Switching

The Mundell-Fleming framework posits that depreciation triggers expenditure switching, in which foreign consumers shift toward now-cheaper domestic exports. This assumes Producer Currency Pricing (PCP), where exports are priced in the domestic currency. In theory, this corrects trade deficits by boosting export volumes and contracting imports. However, the Reserve Bank of India’s attempts to leverage this channel have yielded inconsistent results, as the underlying assumptions of pricing and elasticity often fail to align with modern trade realities.

The Marshall-Lerner Condition: Mathematical and Empirical Nuances

The Marshall-Lerner (M-L) condition states that depreciation improves the trade balance only if the sum of export and import demand elasticities exceeds one. If this sum is less than unity, depreciation paradoxically worsens the deficit as revenue losses from cheaper exports exceed volume gains. The condition is expressed as: |E_x| + |E_m| > 1. 

Econometric studies for India show fractured results. While some long-run models suggest the condition is met, others—particularly those focusing on the subcontinent—indicate that elasticities frequently fall below the required threshold, limiting the effectiveness of currency devaluation.

Method of Modeling	Condition	Elasticity Result	Validation
Ordinary Least Squares (OLS)	1.33 + 0.02 > 1	1.35	True
ARDL Error Correction Model	1.11 + 0.13 > 1	1.24	True
ARDL Long-Run Model	0.53 + 0.25 < 1	0.78	False
ARDL Long-Run Multipliers	3.17 + 0.90 > 1	4.07	True

Data Source: Verification of Marshall-Lerner Hypothesis for the Rupee-Dollar Exchange Rate.

As the empirical data demonstrate, the Autoregressive Distributed Lag (ARDL) Long-Run Model fails the Marshall-Lerner condition, yielding a combined elasticity of only 0.78. Furthermore, broader studies using panel data across South Asian economies (including India, Bangladesh, Pakistan, and Sri Lanka) frequently employ the Hausman Specification and Breusch-Pagan tests to choose between fixed- and random-effects models. These regional analyses often reveal that the combined import and export demand elasticity for South Asia is persistently less than 1, thereby explaining the lack of structural improvement in the trade balance in response to nominal currency depreciations across the subcontinent.

The J-Curve Phenomenon and Time-Horizon Rigidities

The J-Curve effect explains why trade balances often worsen immediately after depreciation. Due to fixed contracts and supply chain lags, import costs rise immediately while export volumes take time to adjust. India experienced this between 2010 and 2013, when the deficit peaked despite significant depreciation of the Rupee. Evidence from 1994–2022 suggests Indian exports respond to exchange rates in the short run but lose this elasticity over the long term, whereas imports are highly inelastic initially but adjust eventually.

The Disconnect: Nominal vs. Real Effective Exchange Rates

Understanding export competitiveness requires distinguishing between the nominal exchange rate and the Real Effective Exchange Rate (REER). While the Rupee has hit nominal lows against the USD (reaching ₹96 in 2026), true competitiveness is dictated by inflation-adjusted costs. The Nominal Effective Exchange Rate (NEER) tracks the Rupee against a basket of currencies. While the NEER shows a structural decline, it does not account for the erosion of purchasing power due to domestic price increases. The REER adjusts for inflation differentials. If India’s inflation exceeds that of its trading partners, the Rupee may appreciate in real terms even if it depreciates nominally. This negates the competitive advantage of a weaker currency. Between 2012 and 2024, India’s inflation averaged 5.8%, compared to 2.5% in advanced economies. This 3% differential created a structural overvaluation. Consequently, nominal depreciation often merely corrected for inflation rather than enhancing export competitiveness. An analysis of the Reserve Bank of India data for the 40-currency NEER and REER indices clearly illustrates this profound disconnect.

Year/Month (Average)	NEER	REER
Base Year: 2015-16	100.00	100.00
2017-18	103.24	105.94
2019-20	98.00	103.20
2021-22	93.13	104.67
2022-23	91.27	102.86
2023-24	90.76	103.73
2024-25 (May)	92.22	104.69

Data Source: Verification of Marshall-Lerner Hypothesis for the Rupee-Dollar Exchange Rate.Through publicly available data. 

Data confirms that while the NEER fell to 92.22 by May 2024, the REER appreciated to 104.69. This real appreciation acted as a headwind for exports. RBI interventions to smooth volatility cannot permanently counter the REER overvaluation driven by domestic inflation. Relying on nominal depreciation is fundamentally flawed if systemic inflation differentials remain unaddressed.

The Dominant Currency Paradigm (DCP) and Invoicing Asymmetries

The Dominant Currency Paradigm (DCP) presents a significant barrier. Most global trade is invoiced in US Dollars (USD), regardless of the trading partners. This decouples the local currency’s exchange rate from the actual price faced by the foreign buyer. DCP introduces rigid USD pricing and strategic complementarities, where firms maintain stable prices in the dominant currency. This significantly mutes the expenditure-switching effect for emerging markets like India.

The Mathematical Muting of Expenditure Switching

Because Indian exports to third countries (e.g., the EU or UAE) are often invoiced in USD, a Rupee depreciation does not lower the price for those buyers. Instead, it merely increases Rupee realizations for the exporter, providing no incentive for foreign consumers to switch to Indian goods. Exchange rate pass-through (ERPT) is low for exports but exceptionally high for imports. A weaker Rupee immediately raises import costs, while export prices remain sticky in USD terms. This traps the economy in an inflationary cycle without boosting trade volumes. DCP-inclusive models correctly predict that net exports can fall following depreciation. For India, a weaker Rupee primarily inflates import costs, as the terms of trade remain flat due to the dominance of dollar invoicing.

• Structural Impediments: The Import Intensity of Indian Exports: The most debilitating factor is the high import intensity of Indian exports. In modern Global Value Chains (GVCs), manufactured goods rely heavily on imported raw materials and components, making depreciation a double-edged sword.
• The Industrial Growth Gap: India vs. Peers: India’s manufacturing stagnation is underscored by its lag behind regional competitors like China and Bangladesh. While China moved rapidly into high-value electronics and heavy machinery, and Bangladesh leveraged low-cost labor to dominate the global textile market, India’s industrial growth has been hampered by infrastructural bottlenecks and an “anti-export” bias. In the textile sector, Bangladesh’s deep integration into GVCs and lower regulatory costs allowed it to surpass India’s export growth. India’s late arrival to the industrial revolution’s efficiency standards has resulted in a manufacturing base that is both import-dependent and less competitive in terms of total factor productivity, rendering currency adjustments insufficient to bridge the gap.

The Economics of Margin Compression

High import intensity causes margin compression. For an exporter using 50% imported inputs, a 10% depreciation increases production costs by 5%. This forces firms to raise USD export prices just to break even, destroying any price advantage gained from a weaker Rupee.

Sectoral Disparities in India’s Export Basket

India’s manufacturing import intensity rose from 13% in 1993 to over 51% by 2014. This integration into “backward” GVCs means India serves as a processing hub vulnerable to currency shocks. Sectors like electronics, petroleum refining, and pharmaceuticals rely heavily on imported chips, crude, and APIs, neutralizing depreciation benefits. A granular examination of India’s top export commodities illustrates this extreme vulnerability:

Export Category	Export Value	Import Intensity Dynamics
Petroleum Products	$61.2 Billion	Massive global refining hub; imports >80% crude oil. Depreciation spikes costs.
Gems and Jewelry	$40.0 Billion	Relies on rough diamond/precious metal imports. High intensity spikes costs.
Electronics & Telecom	$3.24 Billion+	Relies on imported APIs/chips. High vulnerability.
Drug Formulations	$2.17 Billion+	Relies on imported raw active ingredients (APIs).

Only low-intensity sectors, such as agriculture, benefit from depreciation. However, these are not large enough to offset the structural deficits in manufacturing. Enhancing export resilience requires shifting from assembly to deep domestic value addition to reduce this vulnerability.

Policy Imperatives for Export Resilience and Economic Stability

Empirical evidence shows India cannot devalue its way to growth. Policy must shift from exchange rate adjustments to structural reforms addressing the root causes of export stagnation. Key policy imperatives include:

1. Strict Inflation Targeting (during external crisis)  and REER Stabilization: The paramount priority for monetary authorities must be the strict, uncompromising control of domestic inflation. As long as India’s inflation persistently outpaces that of its major trading partners, the Real Effective Exchange Rate will face continuous upward pressure, eroding external competitiveness regardless of the nominal exchange rate. Stabilizing inflation preserves the purchasing power of the currency, allowing for stable, predictable pricing in international contracts and reducing the necessity for disruptive, confidence-damaging nominal depreciations.
2. Deepening Domestic Value Chains and Reducing Import Intensity: To escape the structural trap of high import intensity, India’s industrial policy must aggressively incentivize deep domestic value addition rather than mere final-stage assembly. While initiatives like the Production Linked Incentive (PLI) scheme have successfully boosted gross export headline numbers in electronics and pharmaceuticals, they must be fundamentally restructured to mandate the phased domestic manufacturing of critical intermediate inputs. Fostering domestic semiconductor fabrication, API synthesis, and raw material processing is essential. Reducing the import intensity of exports is the only mechanism that will allow Indian manufacturers to actually benefit from future currency fluctuations.
3. Enhancing Structural Competitiveness and MSME Integration: Export competitiveness in the modern global economy is driven less by currency valuations and significantly more by total factor productivity, logistics efficiency, and technological innovation. Focusing on long-term systemic challenges—about the scale and efficiency of production, the mitigation of infrastructural bottlenecks, the reduction of power and freight costs, and the deep integration of Micro, Small, and Medium Enterprises (MSMEs) into global supply networks—will yield far more resilient, sustainable export growth than any form of monetary tinkering.
4. Promoting Rupee Invoicing and Bilateral Trade Agreements: To subvert the restrictive mechanics of the Dominant Currency Paradigm, India must accelerate strategic efforts to internationalize the Rupee and establish robust bilateral local-currency settlement mechanisms with key trading partners, such as the United Arab Emirates and various Southeast Asian nations. By gradually transitioning export and import contracts away from the US Dollar and toward Local Currency Pricing (LCP), India can slowly restore the elasticity of its trade balance to its own exchange rate. This strategic shift will eventually allow future monetary policy and exchange rate movements to directly and effectively influence external demand.

Conclusion

The Rupee’s failure to catalyze an export boom reflects the realities of the Dominant Currency Paradigm and high import dependence. Nominal depreciation in a high-inflation environment compresses margins rather than capturing market share. India’s path to export dominance requires building advanced, domestically integrated manufacturing ecosystems and ensuring price stability through strict inflation targeting. Only by addressing these structural fundamentals can India achieve sustainable, long-term export-led growth. Although these theories justify the short-term devaluation of the rupee, they fail to explain its long-term depreciation.

The views expressed do not represent the company’s position on the matter. This article does not represent AI-generated content.  Stay informed through the Nitisara Platform and Blogs, and adapt to emerging trends that are poised to thrive in the competitive global marketplace.- https://nitisara.org/category/blogs-updates/. 

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