With the real effective exchange rate (REER) showing that the Indian rupee is overvalued by a whopping 13% as of March, the Reserve Bank of India could potentially buy a record amount of dollars for the second year in a row to keep the country’s products competitive compared with other emerging market economies.
The central bank has already bought $20 billion in the first two months of 2015 after buying a record $82 billion during the 12 months of 2014. The rupee weakened 1.97% in 2014 owing the RBI’s intervention and is expected to weaken 3% in 2015. The currency ended at 62.37/$ on Wednesday. “Our forecast is that the rupee would be around 64.50/$ by December 2015,” said Anindya Dasgupta, MD & head-treasury, Barclays.
In 2014, the RBI bought an unprecedented $82 billion, the highest ever since the economy was thrown open to foreign investors. Historically, the central bank had bought an equally staggering amount only in 2007 (about $75 billion). In both episodes, RBI had cited the rupee’s overvaluation in terms of its real effective exchange rate and volatility-inducing lumpy flows as reasons for its interventions.
“Flows could slow down compared with 2014, but the RBI will continue to buy dollars,” said Ashish Parthasarthy, head of treasury, HDFC Bank. Hitendra Dave, head of global markets at HSBC, agrees. “The difference between 2014 and 2015 is that the current account deficit is far lower. Assuming the same amount of capital flows, it leaves a much higher amount of absorbable surplus for the RBI,” he said.
India’s CAD is expected to narrow to below 1% of gross domestic product in 2014-15 from 1.7% in 2013-14 and 4.7% from 2012-13. Also, the rupee has been appreciating sharply against other currencies, such as the euro and the Japanese yen. The RBI’s REER that measures the currency’s competitive value against a basket of 36 currencies was 113.23 in March, which means the rupee has to depreciate by at least 13% for Indian exports to be competitive.
In March, RBI governor Raghuram Rajan had said an excessively strong rupee is undesirable and that the central bank acts on limiting the volatility in the currency. He had also warned that given massive quantitative easing by central banks, such as the European Central Bank and the Bank of Japan, the threat of flows making the rupee uncompetitive is real.
Indeed, the rupee’s depreciation has been small (around 1.6% so far in 2015) compared with emerging market peers. So far in 2015, Indonesian rupiah has slipped 4%, Brazilian real by 13% and South African Rand by 3.7%.
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