Real Effective Exchange Rate slips to 114.5 in August on falling rupee

The index of Real Effective Exchange Rate (REER) for the month of August slipped to 114.54 as against 121.14 in the corresponding month last year, reflecting a sharp decline of the rupee against the US dollar. This has come at a time when the rupee lost over 14 per cent against the dollar since the beginning of the year.

On Tuesday, the rupee ended lower at 72.70 versus the US currency.

However, the movement of the index on a month-on-month basis since the beginning of this year does not show a sharp decline. In fact, the index moved between 118.42 and 114.54 during February-August after a decline from 121.57 in January. According to experts, this supports the government’s theory that the rupee has not declined against other currencies such as the British Pound Sterling, Euro or Japanese Yen, but has been stable or has gained.

The index of REER is a basket of six and 36 currencies. For an indepth analysis, 36 currency basket has been taken with a base year of 2004-05. The Euro has highest trade weights of 12.69 followed by the UAE Dirham, Chinese Yuan and the US Dollar at 11.44, 10.84 and 8.8 respectively. The index is based on Consumer Price Index (CPI) and reflects the external competitiveness of a country. Conceptually, the REER, defined as a weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries, relates to the purchasing power parity (PPP) hypothesis. When this index is not adjusted with inflation, it becomes Nominal Effective Exchange Rate (NEER). The RBI publishes these indices in its monthly bulletin.

External factors

“The rupee has declined against dollar ,but it is either stable or gained against other key currencies,” a top Finance Ministry official said adding that this shows the strength of the Indian currency. Also, the decline against the dollar is due to external reasons such as the US policies and trade wars that are beyond India’s control, he said.

Commenting on the latest reading of REER, DK Pant, Chief Economist at India Ratings, said although the rupee depreciated sharply against the US dollar in 2018, the 36-country trade weighted REER suggests that on monthly basis, adjusting for inflation in India and our trading partners, the rupee has been fairly stable. He believes that the exchange rate is a necessity but not a sufficient condition for exports growth, which respond strongly to global demand.

On the year-on-year basis, 36-country REER depreciated to 114.54 in August from 121.14 in August 2017.

“A major problem is sharp depreciation of the rupee vis-a-vis US dollar as most commodities are priced in the US dollar and sharp depreciation pushes up the prices impacting our trade and current account deficit, as witnessed in the first quarter of FY19. Moreover, unhedged debt and debt servicing exert pressure on company balance-sheets,” Pant said.

Aditi Nayar, Principal Economist, at ICRA, said as compared to the performance of several other emerging market currencies, the rupee has corrected to a modest extent on an REER basis in August 2018. “With a limited correction in the rupee on an REER basis, it is unlikely to appreciably improve the volume growth of Indian exports,” she said.