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Would you tell me, please, which way I ought to go from here?"

“That depends a good deal on where you want to get to."—Lewis Caroll, Alice in Wonderland

The rupee has moved from a rate of 74.51 to the US dollar on 1 January 2022, to 82.27 at the time of writing this. This has led to concerns regarding rupee volatility and the resultant deleterious effects that such volatility is likely to have on trade and investment, besides India’s overall macroeconomic and financial stability. The Reserve Bank of India has also faced stringent calls to defend the rupee. Which way should RBI go with the exchange rate?

It is true that the almost 10.5% depreciation of the rupee vis-à-vis the dollar in the last 10 months is likely to hurt firms and individuals who have to pay in dollars. Their concerns with such disorderly movements of the exchange rate are then well appreciated. However, the phenomenon of rupee depreciation against the dollar does not automatically translate to a diagnosis of increased rupee volatility per se, with associated policy prescriptions or expectations.

The volatility of a currency, such as the rupee, refers to the frequency and extent of changes in its value vis-à-vis another country’s currency, say the dollar. To understand such volatility, one may look at the daily (or annual) standard deviation from the mean, which is a statistical measure of variation in a set of data indicating its scatter around the average. Using this, RBI data reveals that exchange-rate volatility over the 5-year period 2018-2022 has actually reduced compared to the post-Global Financial Crisis period of 2008-2012 (bit.ly/3S8USYi).

We compared the changes in volatility of the rupee vis-à-vis the dollar for the period January–October 2021 and 2022, drawing on Yahoo Finance data (yhoo.it/3gaG4v6). We noted a decrease in rupee volatility in 2022 at the 1-sigma level (of a single standard deviation), while volatility remained the same at the 2-sigma level. This was even as the average rupee-dollar rate has depreciated by about 5%.

The dollar-rupee daily rate deviated from the 1-sigma level on 72 days over the January to October 2022 period, compared to 76 days in January-October 2021. Again, while the daily exchange rate exceeded the 1-sigma level on 33 days during January-October 2022, this number was 40 days in 2021. On the other hand, the daily rate exceeded the 2-sigma level only on 5 days, both in 2021 and 2022. We conclude that compared to 2021, rupee volatility has not significantly worsened in dollar terms; if at all, the rupee has demonstrated lower volatility of the deleterious sort in 2022.

Looking at rupee movements compared to the euro, the rupee has significantly strengthened against the Eurozone currency both in calendar year 2021 and 2022, but more so in 2022. Thus, while the rupee appreciated over the euro by almost 2.5% over January-October 2021, it has appreciated by almost 5.8% between January to October 2022. The average euro-rupee rate rose from 87.89 in 2021 to 82.13 in 2022.

Turning to volatility, the euro-rupee daily rates remained above the 1 sigma level on 29 days over January-October 2021 while they remained below the 1 sigma level on 41 days indicating an appreciation. In 2022, the euro-rupee rate remained above the 1-sigma level on 40 days, while on 39 days it remained below 1-sigma. The overall days of deviation were more or less similar over the two years. The volatility has reduced at the 2-sigma movement level, with euro-rupee rates deviating from the 2-sigma level over 7 days in 2021 compared to 1 day during January-October 2022. Again, Thus, we can conclude that compared to 2021, the rupee volatility has not significantly worsened in euro terms either.

While volatility hasn’t dramatically increased in 2022, what about concerns of rupee depreciation itself? The fact is that the Indian rupee is currently overvalued against the basket of both its six major trading partners and that of the 40 partners with which we conduct bilateral trade. Thus, the 40-currency trade-weighted basket of the Real Effective Exchange Rate (REER) for August 2022 stood at 103.86, while that of the six-currency basket (trade-weighted) stood at 103.77. At 100 or close to 100, the currency is considered fairly valued. With India’s imports being greater than its exports, it is fine for the currency to remain slightly overvalued, say in a range of 103-104. However, calls for large interventions by the country’s central bank to stem the depreciating rupee against the dollar or stem rupee volatility are misplaced.

A third concern expressed is about the depletion of ‘precious’ foreign exchange reserves to stem rupee volatility. The key fact here, however, is that India’s net draw-down of reserves is much smaller than the headline figure suggests after accounting for valuation losses. Also, the size of the dip in forex reserves as a proportion of the total has been much lower during the current episode of forex management triggered by this year’s Russia-Ukraine conflict and US Fed’s policy tightening, compared to what happened during the Global Financial Crisis.

If India’s goal is to move in the direction of being part of a globalized world, rupee movements need to be treated as a necessary evil of such a course. There is no room for misplaced paranoia when it comes to exchange rate management.

Tulsi Jayakumar is professor of economics and executive director, Centre for Family Business & Entrepreneurship, Bhavan’s SPJIMR

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