New lows for INR

It will happen, but nothing much to worry about…

Macquarie recently released a report indicating that the INR could dip to a low of Rs.71/$. For those who have seen the panic of August 2013, this may almost sound like an encore. But there are some subtle differences. In fact, even at Rs.71/$, there will hardly be much for the Indian economy to worry about. Here is why…

Rupee fall is calibrated…

Over the last 3 years since the currency crisis of 2013, the forex reserves with the RBI have grown from $290 billion to $365 billion. With imports falling consistently over the last 18 months, the forex reserves have grown to cover nearly 11.4 months of imports. That puts India at par with other BRIC nations in terms of forex comfort. That gives the RBI sufficient room to handle a calibrated fall in the rupee rather than a sharp correction like we saw in mid-2013. Even as global trade has shrunk over the last 18 months, India has managed to grow exports at a faster clip than imports. This, combined with a steady inflow of FPI and FDI inflows has ensured that the forex reserves are constantly adding up.

Deficits in much better shape…

Back in 2013 the big worry was the current account deficit. In simple terms, a current account deficit boils down to borrowing for your morning breakfast. When this current account deficit touches 5% of GDP, it is hardly a sustainable scenario. Contrast that with the situation today. The current account deficit has shrunk to just about 0.5% of GDP and most likely we could swing into a current account surplus. Even the fiscal deficit has been maintained at around 3.7% of GDP and despite the pressures of OROP and 7CPC; the government has resisted the temptation of letting the fiscal deficit spiral out of control. These two factors will ensure that the economy is not exactly vulnerable to external shocks. That also provides a support for the rupee and prevents a sharp depreciation.

But, it is actually about the REER…

The real effective exchange rate (REER) captures the extent to which the INR is overvalued / undervalued vis-à-vis a basket of global currencies. Currently, the REER is indicating that the INR is overvalued by nearly 10-11%. Typically, currencies need to depreciate due to inflation differentials. In India, although inflation is nearly 6%, steady inflow of FDI and FPI has ensured strength in the rupee. This has resulted in the REER quoting at a 10% premium. When the INR is overvalued in terms of REER, it is negative for exports since Indian exporters will be pricing themselves out of most markets. A slightly weaker rupee is a must to ensure that exports get the much-needed boost. Rupee falling to 71/$ may actually be beneficial to the Indian economy! ©

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2 responses

  1. Usually I do not read post on blogs, but I would like to say that this write-up very forced me to try and do it! Your writing style has been surprised me. Thanks, very nice article.

    Like

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