Last week, the central bank started measuring the Reer (or the real effective exchange rate) of the rupee, taking 2005-06 as the base year, instead of 2004-05 earlier.
MUMBAI: With its annual change in a yardstick, the Reserve Bank of India (RBI) has made the rupee look far less overvalued.
Last week, the central bank started measuring the Reer (or the real effective exchange rate) of the rupee, taking 2005-06 as the base year, instead of 2004-05 earlier.
Traditionally, the RBI has intervened (by buying up or ‘sterlising’ dollars flowing into the country) to check the rupee’s gains whenever its Reer-based overvaluation has climbed above 5-7%.
So, what is Reer? Simply put, it is the value of the rupee arrived at by measuring it against the currencies of six countries with which India does the maximum trade - the dollar, euro, pound sterling, the Chinese yuan and the Hong Kong dollar.
The inflation rates in these countries, and in India, are also considered when arriving at the Reer.
The choice of a base year is critical because the rupee’s under or overvaluation is basically the extent of divergence from the base year’s nominal or normal exchange rate and inflation.
So the higher the nominal exchange rate and inflation in a base year, the lower will be its overvaluation in the current year.
Call it the statistical dividend.
Thus, data from RBI’s monthly bulletin released last week showed that the rupee was overvalued by only 2.8% in mid-April and 0.5% in March, using 2005-06 as the base year.
Far less than the popular perception that due to rapid appreciation, the rupee was overvalued by over 10% in that period.
But the guesstimate is bang on when you take an earlier base year - say 2003-04 or 2004-05. The RBI revises the base year for Reer calculus each year so that the real strength or weakness of the rupee is measured in more contemporary terms.
This low overvaluation thus explains the RBI’s non-intervention in the currency market since March.
It also helps the RBI and the Centre to continue with their pursuit of lower inflation (something the government desperately wants, after racking up losses in state elections due to high consumer prices) and yet not seem to have compromised on Indi’as export competitiveness.
A rising rupee makes Indian goods costlier for foreign buyers, thereby hurting India’s “export competitiveness”.
Still, despite all this, the RBI could turn more cautious from now on because, in May, even if one were to use the base year as 2005-06, the overvaluation has risen to 6.7%.
That is, the rupee is now in a band that has traditionally triggered intervention from the RBI - 5-7% overvaluation.
The author is senior economist, ABN AMRO Bank. Views expressed herein are personal. E-mail: gaurav.kapur@in.abnamro.com. mailto:gaurav.kapur@in.abnamro.com
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