Rupee Overvaluation: A Misplaced Fear

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The memories of sharply depreciating rupee in mid of 2013, sending panic waves to both government (Widening CAD) and investors( Market crash and Capital flight) are not over yet, and here we are again, in 2017, facing another rupee valuation crisis but this time another way around, which is in form of steep appreciation of rupee.

Doesn’t it make you wonder that what is to be done with rupee? After all, appreciation is a problem now and depreciation has been a nightmare!

If we look at reasons for disappointing 5.7% GDP growth rate for Q1(Apr- June) of FY18, We end up with demonetization, destocking due to GST and an appreciated rupee as the main culprit for the slump.

The findings of experts that a dismal export growth rate also stands somewhat justified based on the fact that the negative contribution of exports to GDP has been worst at -3.3%(Q1 FY 18) in last 3 years viz a viz -0.9%(Q1 FY 17). The problem is with the attitude of holding rupee appreciation as the core and only reason for the fall in the exports.

Why rupee is appreciating?

The most important reason of this steady appreciation of rupee after Dec2016 has been strong investor confidence shown in Indian economy especially by foreign investors due to the resolute stand was taken by the government to improve overall business climate of India followed by a string of strong reform measures.

In line with the fiscal policy, RBI has taken a hawkish stance by shifting from accommodative to neutral monetary policy, signaling its mandate to keep inflation under tight check.

Further, the USA under Trump era favouring protectionist measures has indicated enough that it won’t mind a weak dollar that much!

Also continuously declining trend of volatility in exchange markets accompanied with a significant presence of inflation-adjusted interest rate differentials have caused a sustained rally of the rupee in terms of dollar leading to a 6.3% appreciation since the beginning of the year. The foreign investors have been a net buyer of Rs.1.28 lakh crore worth just in the debt segment leave alone equity!

Why a misplaced fear?

The recent RBI annual report states that appreciation of the currency vs $ has been a general trend across the globe with Chinese yuan appreciating 6%, Brazilian real by 4.2 % and overall appreciation of emerging market countries currency averaged at 9%. So rupee was like a rule rather than the exception in the emerging trend of appreciation of currency as compared to US dollar.

The argument favouring strong RBI intervention in exchange market to stem the appreciative trend and bring some sort of correction in the valuation of rupee stands misplaced because of the limited capacity of the central bank to challenge the market animal spirits.

Also, the decision of RBI to take very limited intervention(Buy dollar- Sell rupee) stands vindicated because of a strong possibility of liquidity upsurge in the markets which can put its primary task of targeting inflation at risk. Further, the central bank has made it quite clear that its objective of intervention in exchange markets is not to achieve a fair price level but to target volatility, which is seen nowhere in the current markets.

Rather than just making a fuss about appreciating currency, Exporters need to focus on other areas where the competitiveness can be enhanced like IT sector which constitutes about 19% of annual exports earning can target diversification of its services and technology in the areas like digital businesses, big data, cloud-computing and artificial intelligence which are currently growing in global demand.

Similarly, the Pharmaceutical sector also has been facing other major challenges apart from appreciating rupee where it can work upon, like increasing regulatory heat and challenge of generic drugs promotion by the USA which is the biggest market for Indian pharmaceutical companies.

Overall, it can be stated that exchange rates should not be considered as the whole and sole factor responsible for export growth. It is the time to recognize the fact that there are no such fair levels of valuations in exchange rate markets. However, a dynamic valuation band can be inferred reflecting the geopolitical and economic realities of those times which can help exporters to foresee and re-establish their trading strategies.

The victims of the appreciation need to recognize the limited capacity of the government or the central bank to intervene in exchange markets amid pushing for a free market agenda. The focus should be on restructuring the areas where competitiveness can be enhanced and realigning the product or services as per the global demand and realities.Rupee needs to be left alone under the watch of the central bank and should be allowed to travel freely in its dynamic territory.

This looks the only viable way!

 

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