Four years ago when the India’s external finances were going through a mini-crisis and the Rs /$ rate was close to 70 no one would have predicted that today it would be around 64. Even as recently as January this year, the Rs /$ rate averaged 68 for the month. Nor is this strengthening of the rupee limited to the rupee-dollar parity. The Reserve Bank of India’s 36-country, trade-weighted (2004-05 base) Real Effective Exchange Rate (REER) index, which takes into account exchange rate movements with respect to 36 trading partners/competitors and adjusts for inflation differentials, also shows a pattern of strengthening from 103 in 2013-14 to 112 in 2015-16 and further to 118 in March 2017. What’s going on?
In some government quarters there is considerable satisfaction about this strengthening of the rupee in recent years and months. It is attributed to “strong fundamentals” of good growth, low inflation, fiscal consolidation and low current account deficits (CADs) in the balance of payments (well below 2 per cent of gross domestic product [GDP]) for four years in a row. While there may be some merit in this point of view, it should not distract policymakers from other pertinent factors and perspectives.
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