The rupee must depreciate 11% for India’s exports to be competetive globally if one goes by the real effective exchange rate (REER). But economists disagree, and so does the RBI.
REER shows that in January the currency was overvalued by 11.46% against a basket of 36 currencies. The rupee was trading on an average around 61.50/$ in January. REER is the measure of the competitiveness of a country’s currency relative to currencies of trading partners and adjusted to the impact of inflation. The rupee’s strength is calculated based on a basket of six major currencies and also 36 currencies by the RBI.
Economists, however, believe that for a net-importing country like India, a certain level of overvaluation is needed. Also, REER tends to amplify overvaluation when adjusted to trade weighted retail inflation differentials. “If we use CPI, we should be adjusting REER by productivity also,” said Abheek Barua, consultant with ICRIER. One of the popular productivity measure is per-capita income.
In the post-policy press meet on February 2, RBI governor Raghuram Rajan noted that adjusted to productivity, the appreciation of the rupee is moderate than that shown by the REER. The RBI changed the inflation index used in REER to consumer price index from the wholesale price index in 2014. “The way to look at REER is just to look at the trend and whether we are depreciating or appreciating. Just looking at the level is misleading,” said Saugata Bhattacharya, chief economist at Axis Bank.
Barua said that adjusted for productivity, the rupee is currently fairly valued. “There are models used by IMF. If we see, we can find that the 60-61/$ level is fairly valued,” said Barua. This explains the RBI’s attempts to keep the rupee in a 61-63/$ band for more than six months now. The central bank has bought as well as sold dollars to keep the currency stable. But largely, the RBI has been a net buyer owing to the big rush of inflows into bonds. Given that the trend in REER has been showing a stronger rupee vis-a-vis other currencies, it is no surprise the RBI has aggressively bought dollars and is likely to keep doing so. While any appreciation is unlikely, the rupee could be let to depreciate moderately, perhaps until the REER shows a reading of 103 or 104.