The much-feared currency war is yet to blow up, but India is already facing its worst battle with rupee. The domestic unit is touching new lows every day and has so far lost over a tenth of its value. In ordinary circumstances, the RBI—custodian of exchange rate management—would sell dollars or tweak policy rates to stem the slide, but right now it’s maintaining an eerie silence.
The government stuck to its stance that rupee is overvalued and even 80-level isn’t bothersome, if other currencies depreciate as well. Former Niti Aayog chief Arvind Panagariya even praised the RBI for doing nothing and advised it to stay its course, as the rupee fluctuation, coming after four years of relative stability, is a necessity. Giving credence to this belief is RBI’s 36 and 6-currency Real Effective Exchange Rate (Reer) that pegs rupee as overvalued by 15 and 23 per cent respectively.
Between 2014 and early 2018, rupee appreciated 15.6 per cent in real terms, making exports less competitive, widening trade deficit to $16.6 billion as on June—the highest in five years. Hence, a falling rupee will mind the gap and attempts to strengthen it will only widen the deficit. But others believe RBI’s Reer is not cast in stone and the rupee fall should be reversed, as the Bank of International Settlements’ broader index (against 61 countries), currently reads 100.39, implying little or no overvaluation.
This creates doubt whether the RBI-computed Reer is the right measure. For instance, the Economic Survey FY17 noted that UAE has an unusually high weight in RBI’s 36-country trade-weighted Reer, but, in reality, UAE has no relevance to India’s competitiveness. Likewise, the euro has the highest weight of 12.7, though its exporters do not compete with us.
Ironically, the dollar has lower weight even though most of our trade, including oil, is settled in dollars. So, to judge rupee’s competitiveness, it’s time policy-makers have a rethink about depreciating rupee and assign higher weights to Vietnam, Bangladesh, Philippines and China, whose exporters compete with us.