BS Number Wise: RBI needs to strike the right balance as rupee falls

As the discussion shifts from internal to external factors, is the RBI being too conservative and could the rupee depreciate more?

The question about the rupee has not changed in the last one year. Now, the discussion has shifted from internal to external factors. The rupee touched a new low against the dollar this week, falling to Rs 78.17. As the Reserve Bank of India (RBI) intervenes in the markets to prevent a free fall — evident from a declining forex chest — the question is whether it is being too conservative in its approach and if the rupee could depreciate more.

To measure how overvalued or undervalued the rupee is, one primary tool is the real effective exchange rate. REER calculates currency differentials by considering price levels. A Business Standard analysis of the nominal effective exchange rate (NEER) and REER presents a conundrum. Against a basket of 40 currencies — selected considering our top trading partners — India’s NEER index depreciated and REER appreciated in the last three years, increasing the gap between the two.

RBI data shows that NEER went down from 98 in 2019-20 to 93.13 in 2021-22 and REER increased from 103.2 to 104.66. This does not bode well for a country’s export competitiveness.
 

A comparison in nominal terms shows a similar trend, indicating that the next year may be no different. While the rupee is one of the worst-performing currencies in Asia in nominal terms, losing 4 per cent against the dollar since the start of the Russia-Ukraine crisis, other emerging market economy currencies have depreciated faster. The Bangladeshi taka has declined 8.2 per cent since the crisis, whereas the Chinese yuan has depreciated 5.7 per cent, and the South African rand has depreciated 5 per cent.

Despite India’s REER appreciating, exports picked up when the pandemic eased and global trade expanded. Competing economies also improved their export performance. A Business Standard analysis found that India’s export growth is not sticky, and it may reverse if global growth slows down — Western economies are moving towards recession.

The rupee, thus, needs to depreciate, but a depreciation is not as easy as it sounds. With inflation rising, depreciation runs the risk of keeping prices high. It also translates into a worsening of the current account deficit. It may even lead to a deterioration in the balance of payments as foreign capital turns to safe-haven assets.

The RBI needs to strike the right balance.