Rupee is undervalued, not unmoored: RBI must ride out global market turbulence
The rupee’s weakness reflects global capital-flow turbulence rather than a deterioration in India’s economic fundamentals, with its inflation-adjusted value at levels last seen during the 2013-14 taper tantrum. RBI must contain volatility without ...
By ET Bureau |
Reuters
The rupee’s depreciation reflects global capital-market turbulence rather than weak fundamentals, giving the RBI room to ride out volatility while using higher rates and inflation control to support a recovery.
Rupee's value against a weighted basket of trading partner currencies, adjusted for inflation, is now at levels seen during the US taper tantrum of 2013-14. Then, as now, rupee's depreciation was on account of international capital flow dynamics rather than any deterioration of India's macroeconomic fundamentals.
The real effective exchange rate (REER) at 90 is an anomaly, and the experience has been that rupee appreciates over the subsequent period when this level is reached. Sanjay Malhotra has flagged irrational market behaviour for the rupee's underperformance, and has emphasised the central bank will intervene to curb exchange rate volatility without defending any particular level for the rupee.
International capital market turbulence is being driven by geopolitical risk aversion. Aggressive monetary tightening has reduced the yield differential between advanced and emerging economy debt.
Relentless selling by FPIs has created unusually high demand for dollars, and India is not receiving offsetting debt inflows to counteract capital flight from equities. Global bond markets are going through an episode of intense sell-off due to surging energy prices, mounting debt burdens of advanced economies and concern over persistent inflation. AI infrastructure funding requirements have pushed up corporate borrowing. RBI has to ride out the bond market turbulence, while keeping rupee on an orderly path.
This week's repo rate hike addresses both low real interest rates in India and narrow yield differential with US treasuries. Interest rates will have to climb a bit more to bring them to historical averages.
RBI's upcycle will play out against bond vigilantism that could influence its trajectory. By acknowledging that rupee is undervalued, RBI is creating space for a recovery once the global market turbulence subsides. Malhotra is anchoring expectations about India's growth by pointing out that rupee has decoupled from the underlying fundamentals. Controlling inflation will be the deliverable against this messaging.
The real effective exchange rate (REER) at 90 is an anomaly, and the experience has been that rupee appreciates over the subsequent period when this level is reached. Sanjay Malhotra has flagged irrational market behaviour for the rupee's underperformance, and has emphasised the central bank will intervene to curb exchange rate volatility without defending any particular level for the rupee.
International capital market turbulence is being driven by geopolitical risk aversion. Aggressive monetary tightening has reduced the yield differential between advanced and emerging economy debt.
Relentless selling by FPIs has created unusually high demand for dollars, and India is not receiving offsetting debt inflows to counteract capital flight from equities. Global bond markets are going through an episode of intense sell-off due to surging energy prices, mounting debt burdens of advanced economies and concern over persistent inflation. AI infrastructure funding requirements have pushed up corporate borrowing. RBI has to ride out the bond market turbulence, while keeping rupee on an orderly path.
This week's repo rate hike addresses both low real interest rates in India and narrow yield differential with US treasuries. Interest rates will have to climb a bit more to bring them to historical averages.
RBI's upcycle will play out against bond vigilantism that could influence its trajectory. By acknowledging that rupee is undervalued, RBI is creating space for a recovery once the global market turbulence subsides. Malhotra is anchoring expectations about India's growth by pointing out that rupee has decoupled from the underlying fundamentals. Controlling inflation will be the deliverable against this messaging.
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