The Garment Exporter: Rupee Depreciation with Imported Fabric
An Indian garment exporter sells 10,000 shirts a month at a fixed dollar price of $25 per shirt. Domestic cost is ₹1,100 per shirt; each shirt also uses imported fabric costing $6. The exchange rate moves from ₹82 per dollar to ₹85 per dollar. The exporter has a one-year contract at $25 and cannot change the dollar price immediately. Fixed costs are ₹40 lakh a month. Assume no change in volume, taxes, or shipping costs. The finance manager says, 'A weaker rupee is always good for exporters because every dollar now converts into more rupees.' A trade analyst replies that the gain depends on imported inputs and on what happens to the dollar price later. The exporter asks you to quantify the effect and advise whether to renegotiate the dollar price after the contract.
1. Calculate profit per shirt and total monthly profit at ₹82 and ₹85 per dollar. How much does the depreciation change profit?
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At ₹82 per dollar:
Export revenue per shirt = $25 × ₹82 = ₹2,050.
Imported fabric cost = $6 × ₹82 = ₹492.
Domestic cost = ₹1,100.
Total cost per shirt = ₹1,100 + ₹492 = ₹1,592.
Profit per shirt = ₹2,050 − ₹1,592 = ₹458.
Total contribution = 10,000 × ₹458 = ₹45,80,000.
Less fixed cost ₹40,00,000 gives monthly profit = ₹5,80,000.
At ₹85 per dollar:
Export revenue = $25 × ₹85 = ₹2,125.
Imported fabric cost = $6 × ₹85 = ₹510.
Total cost = ₹1,100 + ₹510 = ₹1,610.
Profit per shirt = ₹2,125 − ₹1,610 = ₹515.
Total contribution = 10,000 × ₹515 = ₹51,50,000.
Less fixed cost ₹40,00,000 gives monthly profit = ₹11,50,000.
The depreciation raises profit by ₹11,50,000 − ₹5,80,000 = ₹5,70,000 a month, provided volume and the dollar price stay unchanged. The gain is smaller than it would be for a firm with no imported inputs because the rupee cost of imported fabric also rises.
2. Explain why the finance manager's statement that a weaker rupee is 'always good for exporters' is incomplete. Use the exporter's numbers and the concept of the J-curve.
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A weaker rupee raises the rupee value of every dollar received, but it also raises the rupee cost of every dollar paid for imported inputs. The net effect depends on the gap between foreign-currency receipts and foreign-currency costs. Here the export price is $25 and imported fabric is $6, so the net foreign exchange per shirt is $19. Depreciation raises the rupee value of that $19, which is why profit rises.
If the imported content were larger, or the export price lower, the cost increase could outweigh the revenue gain. A firm that imports most of its components may lose from depreciation. Volume also matters: if foreign demand is elastic, the firm may have to cut its dollar price to keep sales; if it keeps $25, volume may fall. The finance manager ignores both the import bill and the demand response.
The J-curve adds a time dimension. In the short run, import and export quantities may be fixed by contracts, so a weaker rupee worsens the trade balance because imports cost more in rupees. Later, quantities adjust and exports may rise, improving the balance. The exporter's one-year contract at $25 is exactly this short-run situation.
3. After the contract expires, should the exporter raise the dollar price, keep it at $25, or follow another strategy? Give a reasoned recommendation with conditions.
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The exporter should not raise the dollar price automatically. At the current exchange rate, keeping $25 preserves the price advantage and yields ₹515 profit per shirt, up from ₹458. If foreign demand is elastic and competitors have not raised their dollar prices, increasing the dollar price could reduce volume enough to lower total profit. Keeping $25 can build market share while the rupee is weak.
Raising the dollar price is more defensible if three conditions hold: foreign demand is inelastic in the short run; competitors have also raised prices or the rupee weakness is industry-wide; and imported input costs are rising enough to squeeze the margin. In that case, part of the depreciation gain can be passed through.
A third option is to hold the dollar price but use the extra rupee margin to build a cushion for exchange-rate reversal. The exporter should also consider whether to lock in forward contracts. The decision depends on demand elasticity, competitor response, import intensity, and expectations about the rupee, not on the depreciation alone.