Money & Banking

Real Effective Exchange Rate rises to 112.41 in Nov; experts say rupee still overvalued

Shishir Sinha New Delhi | Updated on December 12, 2018 Published on December 12, 2018

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Experts say the rupee is still overvalued

The index of Real Effective Exchange Rate (REER) rose to three-month high of 112.41 in November. This is not exactly good news at it will make exports slightly expensive.

This rise came after the rupee appreciated not only against the US dollar but other currencies too during November. REER index is a basket of six and 36 currencies (basket has been taken with a base year of 2004-05).

Euro has highest trade weight of 12.69 followed by UAE Dirham, Chinese Yuan and US dollar at 11.44, 10.84 and 8.8, respectively.

According to the International Monetary Fund (IMF), REER is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs. An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness.

“Thirty-six country trade weighted REER moved to 112.42 in November from 109.47 October showing that in relation to 2004-05, the rupee is still overvalued. Increased overvaluation is due to decline in inflation rate and some improvement in nominal exchange rate,” DK Pant, Chief Economist with India Ratings, said.

The index is based on Consumer Price Index (CPI) and reflects the external competitiveness of a country. Conceptually, REER — is 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. The RBI publishes this index in its monthly bulletin. Index of REER without inflation becomes Index of Nominal Effective Exchange Rate (NEER).

The latest effective exchange rate has come at a time when three key issues are set to affect the rupee in the coming days. These include the BJP’s loss in three key States, resignation of Urjit Patel as RBI Governorpand the appointment of Shaktikanta Das in his place.

In fact, the rupee plunged 110 paise in early trade on Tuesday before ending 53 paise lower at ₹71.85 a dollar due to late rebound. On Wednesday, it was again weak and hovering around 71.95-71.97 a dollar. So far, its year-to-date loss is 11 per cent against 14 per cent a month earlier, but experts feel more pain is yet to come.

More apprehensions

There are two apprehensions — foreign investor may have some concern over the Reserve Bank of India’s independence and policy continuity and this can bring down the rupee to 73 or even 74-level. The investors would like to see if Das’ appointment resolves differences between North Block and Mint Street. First major assignment for Das is to chair the December 14 meeting of the central board of the RBI which is scheduled to discuss re-distribution of power.

Two other factors that can affect the exchange rate is the Modi Government’s strategy in the run up to 2019 general election. Experts feel that if it goes for more populism it will mean fiscal slippage which in turn weakens the rupee. Similarly, oil prices have bottomed out for now and their strengthening will have bearing on the exchange rate.

Published on December 12, 2018
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