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Rupee overvalued vs key currencies despite new lows against $

Last updated on: October 03, 2024 17:01 IST

The rupee remains overvalued against the currencies of India’s trading partners, even as it hit record lows against the dollar in August and September.

Rupee

Illustration: Uttam Ghosh/Rediff.com

According to the Reserve Bank of India’s (RBI) real effective exchange rate (REER) index, the rupee stood at 5.5 per cent above its fair value in August, down from 7.7 per cent in July.

This slight easing followed fears of a US recession and the unwinding of yen carry trades, which exerted pressure on the Indian currency.

 

On September 5, the rupee hit a new low of 83.99 against the dollar, as investors pulled out of yen- and yuan-funded carry trades in favour of the greenback.

However, the RBI’s intervention, selling US dollars in the forex market, prevented the rupee from breaching the critical 84 per dollar mark.

REER is a widely used measure of a currency’s value compared to its key trading partners.

A value above 100 indicates overvaluation, and for the last decade, the rupee has hovered above this benchmark.

Market participants expect the REER to moderate further in the remainder of CY24 and FY25, as India’s rate cuts are likely to be delayed compared to developed countries, where inflation is easing more quickly.

But inflows may help cushion the domestic currency.

“The rupee is overvalued because while it hasn’t moved much, other currencies, particularly from developed markets, have fluctuated more,” said Gaura Sengupta, an economist at IDFC First Bank.

She noted that the rupee’s overvaluation has been a persistent issue.

“During the (Covid) pandemic, the overvaluation had gone because the interest rate and inflation in developed markets had surged.

"Now, inflation in developed markets is coming down at a faster pace than in India.

"So, the overvaluation will persist, though possibly to a lesser degree,” Sengupta said.

In CY24 so far, the rupee has remained relatively stable versus the greenback, depreciating by just 0.59 per cent.

In contrast, the dollar index, which tracks the US currency’s performance against a basket of others, has declined by 0.94 per cent this year.

Among Asian currencies, the rupee was the third most stable against the dollar in FY24, behind only the Hong Kong dollar and Singapore dollar — largely attributable to the RBI’s interventions, which helped limit the rupee’s depreciation to 1.5 per cent that year, down from 7.8 per cent in the previous financial year.

Remarkably, the rupee displayed near-historic stability in CY23, recording its lowest volatility in almost 30 years.

It depreciated by just 0.5 per cent against the dollar — its most stable performance since 1994, when it actually appreciated by 0.4 per cent.

Looking ahead, some analysts predict the rupee could slip to Rs 84 per dollar by March 2025, though inflows and the RBI’s rate cut timeline will be key factors to watch.

Anjali Kumari
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