Is the rupee still overvalued?

Last Updated: Sat, Jun 29, 2013 06:50 hrs

The rupee might have recovered some ground after touching an alltime low on Wednesday, and is now expected to stabilise around 59 per dollar levels. But, with the present global uncertainty likely to continue and the high current account deficit (CAD) not coming down soon, pressure on it will stay for a while.

The relative value of the rupee has fallen in May, when the currency came under pressure following high trade deficit figures and uncertainty over the pace of the US Federal Reserve's easy money programme.

According to Reserve Bank of India data, in May, the REER value of rupee was at 92.01, down from 93.03 in April.

REER indicates the weighted average of a country's currency relative to an index or basket of other major currencies, adjusted for inflation. If the value is less than 100, then it is considered undervalued. Different brokerage and research houses have their respective indices to measure currency valuation.

In May, the currency has depreciated by five per cent against the dollar and in June, the fall was 5.1 per cent. Since April, the rupee has fallen close to 9.5 per cent against the greenback.

Nomura, for example, said in a note that the rupee was still 17.6 per cent overvalued.

Though Nomura expects the CAD to improve to 4.3 per cent in the current financial year, as compared to the previous one, 2012-13 saw the CAD touching a record high of 4.8 per cent of gross domestic product but financing the high CAD is a key risk.

"Overall, given the sizable chunk of gross private capital inflows into India over the last year, we expect lower capital inflows to offset any benefit from a lower CAD, which will exert weakening pressure on the currency," Nomura said.

"Worsening of external vulnerability indicators suggest the Reserve Bank of India (RBI)'s hands are largely tied. We doubt RBI can continue to intervene aggressively, as the more it intervenes, the greater the vulnerability to further capital outflows," it added.

The central bank was not seen intervening aggressively as the foreign exchange reserves, which are $287 billion, could cover imports for six and a half months.

"The ugly news is rupee expectations can rapidly shift towards Rs 62-63/dollar if RBI loses the on-going battle for Rs 60/dollar contrary to our expectations. Our FX strategists expect the rupee to peak at Rs 60/dollar for now," Bank of America Merrill Lynch said in a research report. BofAML has emphasised the beefing up of the foreign exchange reserves as, according to its estimate, RBI cannot sell more than $30 billion to defend the rupee.

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