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Business News/ Market / Mark-to-market/  The need for a weaker rupee
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The need for a weaker rupee

Rupee weakness should be welcomed because in the past few months the real effective exchange rate indicator of the rupee has shown overvaluation by 6%, according to RBI data

Had RBI not intervened in the forex market to buy dollars to shore up the reserves, the rupee would have been highly overvalued. Photo: BloombergPremium
Had RBI not intervened in the forex market to buy dollars to shore up the reserves, the rupee would have been highly overvalued. Photo: Bloomberg

The rupee plunged to a nine-month low against the dollar on Thursday before ending flat. Rupee weakness should be welcomed because in the past few months the real effective exchange rate (REER) indicator of the rupee has shown overvaluation by 6%, according to Reserve Bank of India (RBI) data.

The REER based on a six-currency index on trade-based weights has remained at around the 106 level, at a six-month high for the past two consecutive months (as you can see from the chart), indicating a higher inflation differential compared with its trading partners.

While inflation has been softening in India, some parts of the world are on the verge of deflation, which is reflected in the REER index as the rupee being overvalued, indicating that there will be some pressure on the domestic currency to depreciate in the coming months, said Sunil Sinha, principal economist at India Ratings and Research Pvt. Ltd. However, much also depends on market forces such as dollar demand by oil companies, RBI intervention, etc.

Slowing foreign institutional flows at the end of the calendar year and a strengthening dollar can also exert some pressure on the rupee since it has remained fairly stable, compared with its peers. The rupee is the third best performing currency among the emerging markets so far this year, declining only marginally, while some other emerging market currencies have seen a free fall.

Improving economic fundamentals such as a lower current account deficit driven by the oil price slump and robust capital inflows of around $39 billion have bolstered the rupee. Had RBI not intervened in the forex market to buy dollars to shore up the reserves, the rupee would have been highly overvalued.

A rising REER index does not bode well for exports when they have declined by 5% for the first time in October in seven months. “Given the resurfacing of weakness in global demand and the relative strengthening of the INR versus a number of EM (emerging market) currencies of late, India’s exports might face some pressure in the coming months," added Siddhartha Sanyal, chief India economist at Barclays Plc. This can temper hopes of an export-led recovery.

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Published: 21 Nov 2014, 12:24 AM IST
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