The sharp fall in market value compared to its Real Effective Exchange Rate (REER) has made the rupee an undervalued currency, giving strength to exports. However, the gains will be limited due to weak global demand and costly imports, according to economists and treasury executives.
A real effective exchange rate is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs. The REER index for the rupee declined from 110.40 in February to 103.71 on April 27. When the REER touches 100, the currency reflects its real value.
Since the end of April, the rupee (its market value) has depreciated 6.2 per cent against the dollar and 13 per cent from its 2012 peak in February. According to Reserve Bank of India data, the REER declined from 116.13 for June 2011 to 103.75 in December 2011. It was 108.78 for March and dipped to 103.71 as on April 27.
Economists and treasury executives said an undervalued currency would provide strength to exports. D K Joshi, chief economist with CRISIL, said an undervalued currency puts India in a position of strength.
However, the major influencing factor is the trend in global demand, presently weak.
Some export goods are also import-intensive and the weak rupee has made imports costly. Also, how currencies of competing currencies behave will have bearing on gains, as will inflation, said Brinda Jagirdar, head of economic research at State Bank of India.
The REER model helps economies to value their currencies on a relative basis.
The value of the currency is adjusted by the inflation differential between the domestic economy and the reference economy.
As a result, there is a difference in the rate of fall because of the high inflation in India compared to its trading partners, such as the US, Japan, China, UK, Hong Kong and the euro zone.
“The nominal effective exchange rate was 82.13 in April and assuming inflation stayed at the same level, REER may fall below 90, as the rupee has depreciated by 6.2 per cent since the end of April,” said an economist with a foreign bank.