Speaking at the Ramnath Goenka lecture in New Delhi on Saturday, Raghuram Rajan detailed his analysis of the rupee as he sought to dispel fears that the overvaluation of the currency is to blame for the slowdown in Indian exports. Photo: Bloomberg
Speaking at the Ramnath Goenka lecture in New Delhi on Saturday, Raghuram Rajan detailed his analysis of the rupee as he sought to dispel fears that the overvaluation of the currency is to blame for the slowdown in Indian exports. Photo: Bloomberg

Is the rupee close to its Goldilocks rate? Yes, suggests Raghuram Rajan

Is the Indian rupee overvalued? Or is it undervalued? RBI governor Raghuram Rajan's recent remarks suggest that it may be neither

Mumbai: Is the Indian rupee overvalued? Or is it undervalued? Reserve Bank of India (RBI) governor Raghuram Rajan’s recent remarks suggest that it may be neither and that the Indian currency may be moving in a band close to what he terms as “the Goldilocks rate".

Speaking at the Ramnath Goenka lecture in New Delhi on Saturday, Rajan detailed his analysis of the rupee as he sought to dispel fears that the overvaluation of the currency is to blame for the slowdown in Indian exports.

Indian exports fell for the 14th straight month in January. Between April and January, India’s exports fell 17.7% to $217.7 billion.

Using a graph of the real effective exchange rate (REER), Rajan said the interpretation of the data lies in the eyes of the beholder.

“If a columnist wants to blame the exchange rate for our export slowdown, she can look at the index from the low point of September 2013 and argue it has appreciated 20% (based on the International Monetary Fund measure). Of course, it would be hard to argue that the low point our exchange rate reached in September 2013 represented an equilibrium rate," said Rajan.

The argument, however, could be turned on its head if you look at REER over the last one year.

“..over the last year when goods exports have slowed, the real effective exchange rate has been rather flat. So someone who wants to absolve the exchange rate of blame will point to the recent period," Rajan said.

The REER, based on a basket of currencies of India’s 36 trading partners, showed a 10.38% overvaluation of the rupee in February. At that time, the rupee was trading around 68.50 per US dollar. Since then, the currency has appreciated to close to 67 per US dollar. To have a neutral REER, the rupee must be trading around 74 per dollar in nominal terms.

Rajan, however, went to argue that there is another reason to absolve the currency from talks of overvaluation. That reason is productivity.

“.. offsetting any rise in the real exchange rate is any productivity differential we enjoy with respect to the rest of the world. Assuming conservatively that this is about 2% a year, much of the real appreciation that economists complain about is offset by productivity differentials," said Rajan, concluding that it is hard to pin down the blame for the fall in merchandise exports to the exchange rate.

The governor reiterated that RBI does not stand in the way of any required adjustment in the rupee and allows market forces to determine the rate. It only intervenes to smooth out any volatile patch in the currency.

“The ideal exchange rate for us is neither strong nor weak, it is just right. Typically, market forces get you to this Goldilocks rate. Yet there are circumstances where rapid capital inflows or outflows can move the rate to a level that is unlikely to be supported by fundamentals," said Rajan.

“While RBI would not claim to know precisely what the equilibrium level of the exchange rate is at any given point in time, we intervene to moderate adjustment whenever we believe the movement is extreme, driven by sentiment, and likely to be reversed. Our intent is to prevent overshooting and undue volatility, rather than to stand in the way of the needed adjustment."

The Indian rupee fell to within a whisker of its all-time low of 68.85 per dollar ahead of the budget. The currency, however, rebounded after the government pegged its fiscal deficit target for 2016-17 at 3.5%, reassuring markets that it would not give up on the fiscal consolidation path.

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