Indian rupee: Overvalued or just about right?
A recent op/ed by Ajay Shah in Business Standard questions whether the fears about a strong rupee impacting exports are justified. While we may see a short-term blip, Ajay points out the following:
Over 2002-2007, the US CPI rose by roughly 14% while the Indian CPI rose by 28%: Indian producers lost ground by roughly 14%. At the same time, the rupee went from Rs.49 to Rs.40, an appreciation of 18%. Putting the two together, we apparently lost 32% over this five-year period.
What happened to exports? Total receipts on the current account, which roughly corresponds to exports of goods and services put together, tripled. Merchandise exports doubled. Was this done by ceding profitability? No, profits of the corporate sector, as a whole, rose marvellously over these years.
The other point of interest is the argument that the rupee (at 41 vs. the US dollar) may be overvalued on a REER basis. To this, Ajay counters that REER calculations are extremely imprecise and have little content in explaining key relationships. In fact, the strongest argument against overvaluation is this: if upholding an exchange rate of Rs. 45 requires persistent USD purchases by RBI, then Rs. 45 is not the correct price
Right on! If the RBI stops meddling in the Re:$ rate, the markets will determine it for us - for example, Firms hedge imports fearing rupee fall:
. . . some companies have started hedging their imports in anticipation of the rupee depreciating to 43.75 levels over the next six months, to save themselves the cost of high currency volatility.
Unfortunately, their logic is still driven by expectations of RBI intervention, not a fundamental view on the rupee. But the point is that were the rupee truly a free-float currency, money flows and country-specific factors would determine the “fair value” for us.
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