Rupee down, but steady compared to emerging market peers

The rupee was at the epicentre of the turbulence that rocked the financial market on Monday. The currency opened with a downward gap at 66.38 and went on to close more than one per cent lower.

The rupee is, however, not alone in witnessing such a carnage. Other emerging market currencies such as the Russian rouble (-2.2 per cent), South African rand (-1.8 per cent) and Malaysian ringgit (-1.76) have also recorded equally sharp declines as the possibility of a global slowdown triggered by China sent funds out of emerging market assets.

While the Indian currency is also getting battered in the ongoing rout, it is far less vulnerable than its emerging market peers. If we consider the performance of the rupee so far this year, it has held quite steady compared to its other EM peers. The currencies of commodity exporting nations such as Brazil, Russia and South Africa have, for instance, declined 23, 15 and 10 per cent against the dollar in 2015. The rupee has, however, recorded a YTD fall of only 3.85 per cent.

Strong performer in 2015 This strength in the rupee even as other currencies declined has eroded the competitiveness of the Indian currency. The 36-country Real Effective Exchange Rate of the rupee that takes into account, the inflation adjusted exchange rates against its trading partners, is currently at 111.9, indicating that the currency is overvalued to the extent of almost 12 per cent.

The RBI has so far been using the rupee strength to shore up its reserves. It has been a net purchaser of US dollars this year, buying almost $36 billion in the first six months of 2015. This is against a net purchase of $32 billion in the entire 2014. The rupee’s resilience despite these purchases underlines its inherent strength.

The dollar purchases have helped bolster reserves to $353 billion currently. The RBI Governor has said that these reserves will be used to protect the rupee, if needed.

The strength in the rupee is due to the fact that the country has been able to improve its macros considerably since 2013. India’s current account deficit was spinning out of control and stood at 5 per cent of GDP in June 2013, but this is reined in at 1.36 of GDP currently.

India is also one of the few countries with a positive real yield.

With the CPI at 5 per cent and bond yield at 7.7, we currently have a real yield of above 3.9 per cent, which is among the highest worldwide. India being a net commodity importer stands to gain from the fall in commodity prices.

It may also be recalled that it was due to the shorting of rupee futures in offshore market such as the Non-Deliverable Forwards market that had caused the rupee to spiral lower in 2013.

Various measures taken by the RBI since then — such as imposing curbs on proprietary trading by banks, ruling that forex positions of banks in exchange traded currency instruments and positions in inter-bank forward market cannot be offset against each other — have somewhat reduced the arbitrage trading between offshore and onshore market.

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