Rupee is still overvalued despite heavy devaluation in last few days

Despite the continued depreciation of the rupee, economists say the local currency is still in line with the inflation index (along with its trading partners) – the real effective exchange rate or REER – raising expectations that it will fall further.

The November figure – the latest number released by RBI officials – showed that the REER was 108.14. This means that the rupee is overvalued by 8.1 percent relative to its intrinsic value. The rupee has depreciated by around 2 percent since December.

“Devaluation in INR would have reduced overvaluation on REER basis. We forecast the index to decline to 106 to 107 levels at present against 108.1 levels in November.” Gaura Sengupta, Chief Economist, IDFC First Bank said. “The rupee is still overvalued on a RER basis as other currencies weakened further against the dollar in December and January.”

Since November 5, when the US elected Donald Trump as its next president, 26 global currencies have depreciated by an average of 2.5%, according to Anindya Banerjee, head of markets at Kotak Securities.

“The rupee depreciated by around 2.3 per cent over the same period and is therefore still overvalued in terms of REER,” he said.

The RBI’s official stance is that it does not see any particular level of the rupee while it only intervenes to ensure stability and orderly movements in the currency and to prohibit extreme volatility. However, market participants believe that the central bank does not like to see the currency breach popular benchmarks like REER and ensure that it is in alignment with these indicators.

There will be significant uncertainties from Trump’s policies. Banerjee said, “Until there is a reversal in the dollar index, the rupee will remain under pressure. The situation will become clearer when Trump starts taking his policy decisions.”

Besides, a lot will also depend on how inflation plays out at home and in trading partners. The New York Fed’s Survey of Consumer Expectations reported that consumers expected inflation to rise over potential tariffs during Trump’s second term. “Another factor is the reduction in the inflation gap between India and our trading partners which will reduce the overvaluation to some extent,” Sengupta said.

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