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The Indian rupee, despite experiencing a significant depreciation in recent days, remains overvalued according to economists. This assessment is based on the real effective exchange rate (REER), an inflation-adjusted index that compares the rupee's value against a basket of other currencies. The November REER index, the latest figure officially released by the Reserve Bank of India (RBI), stood at 108.14. This indicates that the rupee is overvalued by approximately 8.1% relative to its intrinsic value. While the rupee has weakened by about 2% since December, this depreciation hasn't been sufficient to offset the overvaluation. Gaura Sengupta, chief economist at IDFC First Bank, estimates the current REER to be between 106 and 107, still indicating overvaluation. This is partly because other global currencies have also weakened against the dollar during December and January.
The significant weakening of the global currencies is largely attributed to the election of Donald Trump as US President in November 2016. According to Anindya Banerjee, head of markets at Kotak Securities, 26 global currencies depreciated by an average of 2.5% since Trump's election. While the rupee's depreciation of approximately 2.3% during the same period was notable, it was not enough to fully correct the overvaluation indicated by the REER. This suggests that further depreciation of the rupee is likely in the near future unless other factors intervene.
The RBI maintains a stance of non-intervention in specific rupee levels, focusing instead on maintaining stability and orderly movements in the currency market. However, market participants generally believe that the central bank does monitor key indices like the REER to ensure the rupee remains within a reasonable range. The uncertainty surrounding the economic policies of the Trump administration is placing significant pressure on the rupee. Until there's a reversal in the dollar index, the rupee is expected to remain under pressure. Banerjee highlights that a clearer picture will emerge only when Trump’s policy decisions start to manifest and their impact on the global economy and the value of the dollar becomes apparent.
Beyond the impact of US policies, domestic and international inflation rates will play a significant role in determining the future trajectory of the rupee. The New York Fed's Survey of Consumer Expectations indicates that US consumers anticipate higher inflation due to potential tariffs during Trump's second term. Sengupta emphasizes that a reduction in the inflation differential between India and its trading partners could also contribute to lessening the rupee's overvaluation. The interplay of these global and domestic economic factors will continue to shape the value of the Indian rupee in the coming months. It is a complex situation with many interdependent variables, making precise predictions challenging. The current overvaluation and uncertain global economic climate warrant careful monitoring of the situation.
In conclusion, the recent depreciation of the rupee has not fully corrected its overvaluation, as evidenced by the REER index. The continued uncertainty surrounding Trump's policies and the potential for increased inflation, both domestically and internationally, will likely exert further downward pressure on the rupee. While the RBI's stance is to maintain market stability, the interplay of these global and domestic economic forces suggests a high probability of further rupee depreciation. This necessitates careful monitoring of the economic landscape by both the government and market participants. The future value of the rupee remains contingent on the resolution of several crucial economic factors, creating an atmosphere of both opportunity and risk for investors and businesses.
Source: Rupee still overvalued despite steep depreciation in the past few days