Currency capers

Currency capers

The rupee touched an eight-year high on Wednesday. We expect a lot of loose talk on how a strong rupee will harm export competitiveness.

The indicator that matters is the real effective exchange rate (REER), an inflation-adjusted index of the rupee’s value against the currencies of our 36 major trading partners.

What does REER tell us? The latest numbers on the RBI website show that the rupee was still mildly under-valued in December 2006. That could have changed a bit recently, but we are nowhere near the large over-valuation of 2004 and 2005.

Why is REER within control though the rupee has climbed against the dollar? It’s because other currencies like the yuan and the yen have risen even more steeply against the dollar. This is perhaps the first step in a global currency realignment, as the US struggles with its trade deficit. A long decline in the dollar is inevitable, and the rupee is bound to be part of the action.