Rupee Depreciation and an Exporter's Dollar Price
Sunrise Leatherworks exports 10,000 bags a month, invoiced at USD 20 each, and buys imported fittings and lining worth USD 9 per bag. Its domestic costs - wages, rent and local hides - come to ₹45 lakh a month and do not vary with the exchange rate. The rupee has just moved from ₹80 to ₹84 per dollar, a 5% depreciation, and dealers abroad are pressing for a lower dollar price. Sunrise's export demand is estimated to be inelastic, with a price elasticity of about 0.6. Its main competitors in Italy and Vietnam have not changed their dollar prices. The finance director wants to hold the dollar price at USD 20 and 'pocket the windfall'; the export manager wants to cut the dollar price to USD 19.05 so that the rupee price to buyers stays unchanged. The firm has no currency hedge in place and its contracts run for one month at a time.
1. Compute monthly profit at ₹80 and at ₹84 per dollar if Sunrise holds the dollar price at USD 20. Why is the rupee gain smaller than 5% of export revenue?
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Export value = 10,000 × USD 20 = USD 2,00,000; imported inputs = 10,000 × USD 9 = USD 90,000.
| Item | At ₹80 | At ₹84 |
|---|---|---|
| Export receipts | ₹1,60,00,000 | ₹1,68,00,000 |
| Imported inputs | ₹72,00,000 | ₹75,60,000 |
| Domestic costs | ₹45,00,000 | ₹45,00,000 |
| Profit | ₹43,00,000 | ₹47,40,000 |
Why the gain is only ₹4.4 lakh, not 5% of ₹1.68 crore (₹8.4 lakh). Depreciation works on both sides of the trading account. Sunrise has a 45% import content, and the rupee cost of those inputs rises by the same 5%. The gain equals the rate change multiplied by net foreign exchange earnings: 4 × (2,00,000 − 90,000) = 4 × 1,10,000 = ₹4,40,000. Exporting more imported content means keeping less of any depreciation.
Judgement: holding the dollar price is clearly profitable in rupee terms, but the firm should recognise that its real competitive gain is on value added, not on turnover - roughly 5% of the domestic value-added portion. Any further depreciation of the rupee would help it by the same formula, and any appreciation would hurt just as mechanically, which is why the absence of a hedge matters.
2. Evaluate the export manager's proposal to cut the dollar price to USD 19.05, and explain the role of the 0.6 elasticity.
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The proposal. Setting USD 19.05 keeps the rupee price at about ₹1,600 per bag (19.05 × 84 ≈ 1,600). The dollar price falls by 4.76%.
Volume effect = 0.6 × 4.76% = +2.86% → 10,286 bags Rupee receipts = 10,286 × ₹1,600 = ₹1,64,57,600 - up only 2.86%, not 5% Imported inputs = 90,000 × 1.0286 = USD 92,574 → × 84 = ₹77,76,216 Profit = 1,64,57,600 − 77,76,216 − 45,00,000 = ₹41,81,384, about ₹5.6 lakh worse than holding the price.
The elasticity logic. Cutting the dollar price in proportion to the depreciation buys volume, and the rupee revenue gain equals the volume gain. That beats holding the price only when e × 4.76% > 5%, i.e. e > about 1.05. At e = 0.6 the volume gain is far too small. With an import bill that also rises with volume, the required elasticity is higher still. The manager has applied a competitive-share instinct that is valid for elastic demand to a product whose foreign demand is inelastic.
Recommendation: hold the USD 20 price, keep the rupee gain of about ₹4.4 lakh, and do not pass the windfall to dealers as a price cut. If the concern is long-run share rather than this month's margin, a limited non-price concession (extended payment terms, faster dispatch) protects the relationship without resetting the reference price, which is hard to raise later.
3. What risks should Sunrise weigh if it keeps the dollar price at USD 20, and how would a forward contract or a price-adjustment clause change the picture?
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Risks of holding the dollar price.
- The elasticity is a short-run estimate. If competitors' unchanged dollar prices make switching easy for dealers, actual e could exceed 1.05 and the 'hold' decision would then destroy share and revenue. The whole calculation hinges on an estimate the firm should test with one month's order data.
- Competitors may move. Italy and Vietnam face the same rupee-relative advantage without having gained it; if they cut dollar prices, Sunrise is the high-price supplier.
- Reversal of the exchange rate. The contracts are monthly and there is no hedge, so a return to ₹80 or an appreciation would erase the gain on the same 5%-of-net-FX formula, without any offsetting price change.
- Customer resistance. Buyers who know the rupee moved will push for a share of the windfall; conceding openly makes the USD 20 price a bargaining floor rather than a list price.
Effect of a forward contract. Selling the expected USD 2,00,000 forward at ₹84 locks the gain and removes the risk of reversal, but it also removes the benefit of any further depreciation and may require margin with the bank; forward cover on the net USD 1,10,000 exposure is the economical choice.
Effect of a price-adjustment clause. An exchange-rate clause sharing movement beyond a band (say beyond ±2%) with the buyer converts a windfall into a shared, transparent outcome and reduces renegotiation pressure, but it also caps the gain. Given inelastic demand and a one-month contract cycle, the sensible combination is: hold the dollar price now, hedge the net exposure, and use the data from the next two months to replace the 0.6 estimate with a measured one before making the pricing policy permanent.