The rupee was overvalued by 12.21 per cent as on April 18, 2007, according to the Reserve Bank of India. The rupee, which was Rs 41.98 per dollar on April 18, surged further to close at a nine-year high of 41.67/68 on Monday.

According to the six-currency, trade-weighted real effective exchange rate (REER), the rupee has appreciated by 7.8 per cent since April 2006, when the rupee was overvalued by 4.12 per cent.

The rupee has been gaining on the back of large capital inflows due to foreign fund investments, foreign direct investment (FDI) and overseas borrowings by companies and banks.

The RBI, which is staying away from intervening in the foreign exchange market to prevent the rupee from appreciating, has also added to the domestic currency's strength.

The rupee had gained by over 2 per cent in March 2007 alone as the RBI refused to buy dollars and infuse rupee liquidity, diluting its tight monetary stance.

Capital flows during 2006-07 were substantially higher than a year ago led by FDI flows on the back of strong growth prospects and buoyant investment demand. FDI inflows at $16.4 billion during April 2006-January 2007 were substantially higher than the inflows of $5.82 billion in 2005-06.

NRI deposits increased to $39.13 billion from $35.13 billion at the end of March 31, 2006, and Indian companies and banks raised a total of $28.71 billion from overseas markets in 2006-07, 29 per cent more than a year earlier.

The country's foreign exchange reserves crossed the $200 billion mark at the end of March 2007, with forex interventions by RBI during 2006-07 (upto February) totalling more than $24 billion, almost triple the amount of interventions in 2005-06. However, with headline inflation continuing to average over 6 per cent in March, the central bank did not mop up dollars from the forex market.

According to Ajit Ranade, chief economist, Aditya Birla Group, the current spurt in the rupee was unusual, and mainly on account of the RBI not having intervened in the forex market.

"The underlying macro economic indicators, be it current account deficit, fiscal deficit or domestic inflation, all point to rupee weakening," he said.

Reflecting the growing interest rate differential, in view of increasing domestic interest rates, the one-month forward premia has increased to 6.99 per cent in March 2007 from 3.79 a year earlier. The six-month premia has also moved up to 3.8 per cent from 2.43 per cent over the same period.