Rupee at 70/$

It really may not be too far off, but then no worries!

As the Rupee hovers around the 67/$ mark, it once again raises the specter of the rupee crossing 70/$. The memories of the 2013 crisis are still fresh in the minds of analysts and traders. With the US likely to hike Fed rates in December or early next year, it is all the more likely that the rupee could breach 70/$. However, despite an additional 5% depreciation, there is not much to be worried about. Here is why…

REER shows rupee overvalued…

 The real effective exchange rate (REER) is a very good fundamental indicator of whether a particular currency is overvalued or undervalued. Interestingly at 67/$, the rupee is very close to its overvaluation peak in the past. REER considers the differential in inflation in calculating whether the exchange rate is undervalued or overvalued. If you compare the current exchange rate with the rate in mid-2013, the depreciation has been just about 3%. But considering the annual inflation differential of 5% between the US and India, the rupee should have actually depreciated by nearly 13% in this time period. Thus REER effectively captures that the rupee is currently overvalued by 10% and needs to depreciate.

Fall in rupee has been calibrated…

The dangers in a falling rupee are two-fold. Firstly, it queers the pitch for importers and dollar currency borrowers. They need to pay in dollars and it becomes expensive when the rupee depreciates. The second issue pertains to foreign portfolio investors. When the rupee depreciates suddenly, it throws a lot of hedging calculations off track. That is why during volatile currency times, most of the portfolio investors prefer to exit the markets and wait in the sidelines.

Both the above problems can be addressed by adopting a calibrated approach. That is exactly what the RBI has done. During the year 2015, the rupee has gradually depreciated from 63/$ to 67/$. This calibrated depreciation ensures that importers, borrowers and portfolio investors are able to project the likely dollar value and hedge their positions accordingly. That largely mitigates the risk of a sudden fall in currency value.

Macros are well under control…

But finally, it boils down to the fundamentals and what checks and balances does it have. Firstly, the current account deficit and fiscal deficit is well under control. That will ensure that the rupee will not come under pressure. Secondly, debt has become an important component of portfolio inflows and attractive rates will keep the debt money coming in. Lastly, you do not get 7.5% GDP growth for a song. It will ensure that fall in the rupee will be limited and calibrated. Touché! ©

Religare Online provides detailed information and news on currency markets to help you make smart investment decisions.

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