The rupee continues to be overvalued as per the Reserve Bank of India’s (RBI) real effective exchange rate (REER), standing at 5.5 per cent in August. However, it has moderated from 7.7 per cent in July, on the back of fears of recession in the US and the unwinding of widely-used yen carry trades in August.
The rupee depreciated to record lows against the US dollar during August and September, as investors exited carry trades that used the Chinese yuan and Japanese yen to fund long positions in the rupee. The local currency hit a record low of Rs 83.99 against the US dollar on September 5 of the current year. However, the RBI’s intervention in the foreign exchange market via dollar sales prevented the rupee from hitting the psychologically crucial mark of Rs 84 per dollar.
REER is a widely-used metric to assess a currency’s value relative to its trading partners. A reading above 100 signals overvaluation. Over the past decade, the rupee has consistently remained above this threshold.
Market participants said that REER might moderate further in the current calendar year (CY24) and financial year (FY25) on the back of inflows.
“The rupee is in the overvalued range as per REER, because the INR hasn’t moved much, while other currencies have, especially the developed market currencies,” said Gaura Sengupta, economist at IDFC First Bank.
“Overvaluation of the INR has persisted for a while now; it is not a new phenomenon. Very briefly during the pandemic, the overvaluation had gone, because the interest rate and inflation in developed markets had surged, and they had coincided with us. So, the REER for a brief period, the overvaluation had gone. Now, what we are seeing is that inflation in developed markets is coming down at a faster pace than in India. So, the overvaluation will persist, though the extent might reduce a bit,” she added.
The rupee has remained largely stable against the US dollar in the current calendar year (CY24), depreciating by 0.59 per cent so far. Meanwhile, the dollar index, which measures the strength of the US dollar against a basket of currencies, has fallen by 0.94 per cent in the current calendar year.
The rupee was the third most stable Asian currency against the US dollar in FY24, after the Hong Kong dollar and Singapore dollar, primarily due to timely intervention by the RBI. The rupee depreciated by 1.5 per cent in FY24, compared to 7.8 per cent in the previous financial year (FY23).
In CY23, the local currency displayed remarkable stability against the dollar, marking the least volatility it has seen in nearly three decades. The Indian unit experienced a marginal depreciation of 0.5 per cent against the greenback. The last time the Indian unit exhibited such stability was in 1994, when it appreciated by 0.4 per cent.
“The rupee might depreciate to Rs 84 per dollar by March 2025, as it is expected to remain stable because of inflows, and we also have to see the timeline of the rate cut by the RBI,” said the treasury head at a private bank.
First Published: Oct 02 2024 | 6:02 PM IST
