The rupee is undervalued as compared to its peers, shows the latest data from the Reserve Bank of India (RBI), even as the local currency keeps hitting new lows.
As of July, the real effective exchange rate (Reer) of the rupee fell to 98.79, the lowest since February 2019.
Reer was at 100.36 in June.
Market participants said that India’s inflation rate remained lower than that of many of its key trading partners, allowing Reer to decline, making the rupee appear more competitive in real terms.
Additionally, foreign institutional investor (FII) outflows from equity and debt markets, amounting to approximately Rs 60,000 crore, exert downward pressure on the rupee, further contributing to the fall in the Reer index.
Rising prices of gold and energy also inflate the import bill, putting additional strain on the rupee and pushing the Reer index lower.
“The RBI generally tries to keep Reer at 96-104 (not too undervalued or overvalued), to balance competitiveness and inflation,” said Kunal Sodhani, head of treasury, Global Trading Centre, FX & Rates Treasury, Shinhan Bank India.
“India’s inflation is lower than that of its trading partners, which lets Reer fall (the rupee looks cheaper in real terms).
"Also, when there are FII outflows, the rupee tends to weaken, pushing the Reer index to fall.
"Rising gold and energy prices reflect a higher import bill, which again leads to weakness in the rupee, taking the Reer index lower,” he added.
According to the monthly bulletin, the RBI has scaled back its market intervention, selling only $2.5 billion in July.
The outstanding net short dollar position in the forward market for the rupee fell further to $57.8 billion by the end of July, against $60.3 billion at the end of June.
Additionally, there were no operations in currency futures for the fourth consecutive month.
This suggests that the central bank may be comfortable with a gradual and orderly depreciation of the rupee to support export competitiveness, said market participants.
“Reer could have further declined in August and September,” said a dealer at a state-owned bank.
In May, Reer had increased after five consecutive months of moderation since December.
Prior to the decline, Reer had climbed steadily from 103.66 in January 2024 to a peak of 108.14 in November.
Reer adjusts the nominal effective exchange rate (Neer) to account for inflation differentials between India and its major trading partners.
A Reer value above 100 indicates an appreciation of the rupee relative to the base year, potentially making Indian exports less competitive in global markets.
Additionally, the latest data by the central bank showed that India’s foreign exchange reserves hit $703 billion near the record high of $705 billion.
Reserves crossed $700 billion for the first time since July.
