The Indian Economy Blog

October 13, 2005

Is The Indian Rupee Overvalued?

Filed under: Banking,Business,Fiscal policy,Monetary policy,Trade — Prashant @ 1:03 pm

As per the India Stock Blog

The Rupee is fundamentally weak, but has been propped up by overly positive sentiments of Foreign Institutional Investors (FIIs), which are now moderating…

Factors weighing on the Rupee:

Trade and Current Account Deficit
On the surface it would appear that oil would be the cause of the widening trade deficit. But non-oil imports are growing faster than oil imports. The largest growth in imports is… gold!

Fickle Financing
Financing is largely being driven by fickle sources such as External Commercial Borrowings (ECBs), Non-Resident Indian deposits (where carry trades are getting wiped out every day, with the Federal Reserve likely to up the U.S. fed funds rate at the next two meetings). The volatile FII inflows are unlikely to continue at the soarching pace they have set so far this calendar year

REER Overvalued
The rupee is overvalued on the trade weighted index, even if you take into account China and Hong Kong in the new REER index that the Reserve Bank of India (RBI) — India’s central bank — is constructing

The Rupee is Quasi Dollar Pegged Despite denials by the RBI, the rupee is pegged to the dollar unofficially. The dollar has strengthened significantly since May (as measured by the dollar index); so the rupee had to weaken.

Withdrawal Pressures in December
In December, the 5 year IMD deposits of US $ 5 bn issued by SBI are due for redemption; this will put pressure on the rupee.

As per the Big Mac equivalent test couple of months ago, the rupee was way undervalued– by 59%.

Q) What do readers think?


  1. Unfortunately, there is no straight answer to your question. For an economy with completely open capital accounts and a freely floating exchange rate, it is enough to look at current account deficits to reach a judgement about whether the currency is going to appreciate or depreciate. In the medium to long run, mind you. In the short run, things like capital flows will be the main drivers of exchange rate movements. The problem in arriving at a judgement about the rupee is the following : India has only a partially open capital account. Consequently, the RBI can do independent monetary policy while also targeting the real exchange rate which is what it did through much of the 90s, allowing the nominal exchange rate to depreciate steadily since India had relatively higher inflation rates. In such an environment, it is really difficult to pin down any kind of equilibrium real exchange rate, relative to which judgements can be made(I suppose it can be done, but its not an easy back-of-the-envelope calculation, and I would not trust the Big Mac index too much in guiding my hand). You have outlined 5 factors weighing on the rupee. In the short run (one or two quarters ahead), I would argue that factors 2 and 5 would drive market valuations of the rupee. But a central bank which can would typically try to smoothen these fluctuations out, so I expect the RBI to intervene if these factors create too much volatility in the rupee’s value, and so you would need to take into account the RBI’s reaction function to arrive at a judgement about the direction of the rupee. Do we know what the RBI’s reaction function is? No. In the long run, where is the rupee going? I really have no clue.

    Comment by Deep — October 13, 2005 @ 11:04 pm

  2. Hi,

    Two more factors to be kept in mind is the interest rate differential as well as growth in export (besides the exporters lobby for weaker rupee).

    Rupee has already touched the 10 1/2 month low and if the FII money keeps pouring into the stock market as it has in last 9 months of 2005, then we might see some stability.

    RBI may not be keen to intervene as the interest rates as well the inflation are under control, hence their policy would be restricted to reducing the volatility of the Rupee. Besides with the introduction of Rupee options, the depth in the Rupee market has increased manifold.

    signing off…

    Comment by Prince — October 14, 2005 @ 2:35 am

  3. Price
    Actually, interest rate differentials will not be very helpful, since capital controls introduce a wedge in the interest parity condition, and this wedge depends on the RBI’s reaction function. Rather (and contra to the last sentence in my earlier comment), productivity differentials between India and her prominent trading partners will be more informative about where the rupee is headed in the long run. Countries with higher productivity typically have more appreciated exchange rates.

    Comment by Deep — October 14, 2005 @ 5:05 am

  4. i had been going through this recently during some research ( and also )and i think this holds the key to a fresh look at your question. To look at some of the factors that normally impact exchange rates:

    1. The current account deficit of the US is $ 680 Billion . India’s is a + balance of $4.87 Billion

    2. Trade
    US Total exports and imports – $650 Billion and $1.4 Trillion
    India Total exports and imports – $69 Billion and $89 Billion

    More relevant the trade balance between India and US
    Exports – Imports= $12 Billion – $5.4 Billion is $6.6 Billion in India’s favour

    3. Interest rates: India’s interest rates have climbed down by over 1000 points in 10 years (1995-2004)While I do not have the comparable rate for USA I am sure there is no comparison. It still remains between 3-4% over the USA, making it attractive to buy rupees. the fear of inflation is also down.

    4.Foreign exchange reserves of the USA including gold (official) is $86 Billion
    India’s is about $ 126 Billion
    If india sells dollars, ( of which it has no great need) rupee would have to appreciate

    5. External debt as a percentage of GDP (PPP)
    for USA – is 12%
    for India – is less than 4%
    at some time or other soon the USA has a debt trap to worry about. India doesn’t

    1.FDI flow in India is negligible ( $5 Billion)and has only decorative effect on indices

    2. Gold , while nominally a dead investment is actually a strong and vibrant financial instrument ( ask pawn brokers) India’s undeclared assets in gold should be of the order of $2.5 – 5.0 Trillion

    while this merits a more rigorous analysis, basic takeaway should be that the unofficial pegging of the rupee to the dollar ( done by indian government)is wrong. the moment it is removed, there is no doubt that the rupee should appreciate.

    JAI HIND!! :-)

    Comment by radesh rangarajan — October 14, 2005 @ 8:47 am

  5. Hi Prashant,

    Thanks for linking to this article, and thanks for the trackback (wouldn’t have found your blog otherwise).

    We’ve syndicated some of the thoughtful comments of your readers back at the original article,

    Please email us if there are any issues.

    Seeking Alpha editors

    Comment by — October 16, 2005 @ 5:20 pm

  6. Don’t know enough about whether the Rupee is over-valued or not – but wanted to add that you the Big Mac equivalent thing holds no value. The whole reason the Economist doesn’t include the Rupee, is because the Maharaja Mac is not the same as a Big Mac. The Big Mac conatins beef patties, the Maharaja Mac (used to be goat-meat) and is now chicken. No, I’m being serious here – because of this, you can’t compare the price of a Maharaja Mac to the Big Mac (different inputs, different cost). So that Big Mac equivalent thing doesn’t really hold…

    Comment by TTG — October 18, 2005 @ 2:59 am

  7. A non industrialized country with a small traded sector (exports are about 12% of GDP), cannot really run a large current account deficit except to the extent that it can get FDI. Until the country gets a large amount of FDI, it will have to run close to a trade balance – which means that the value of the rupee should reflect the price level of *traded goods* with india’s trading partners.

    The Big MAC index is a measure of non-traded inputs (rent, transport, electricity) and therefore not particularly relevant.

    Comment by amitabh — October 20, 2005 @ 10:00 pm

  8. The biggest concern in the context of long-run exchange rate stability is the massive public debt and persistently high fiscal deficits. Something that may prop the rupee up however is the dearth of investment opportunities available to international savers. Capital inflows are discretionary however, and many emerging markets are competing for the attentions of the FIIs. There is no need to expect a decline in capital inflows: quite the opposite in fact. However policy makers would be wise to not take these inflows for granted. As an example, the recent move to impose hiring quotas on the private sector may reduce expected returns all around and should certainly be nipped in the bud. Is it too much to ask, given the slow pace of divestment and the many hurdles to privatization of PEs, that the public sector at least stay out of the way of the private sector? It is not just the act of imposing private sector quotas, but the attitude it symbolizes, that is damaging.

    Comment by rashmi — December 25, 2005 @ 9:24 pm

  9. hi deep!
    In your comment on 0ct 13, you said that since rupee is partially convertible, RBI can do independent monetary policy while also targetting the REER. does this have anything to do with the impossible trinity? can you elaborate more. What does this say about the valuation of the rupee

    Comment by aarti — December 27, 2005 @ 6:16 pm

  10. can someone explain in lay mans terms about how the rupee is valued,2) how does one decide that the rupee is 45 to a dollar3)what happens when we appreciat or depritiate our currency.

    Comment by savio — May 22, 2006 @ 3:42 pm

  11. hi….statements of various authorities like sonia gandhi,chidambram,,puts an admirable effect on inflow of FII’S.

    Comment by aditya — October 12, 2007 @ 2:22 pm

  12. You are absolutely correct in writing that the Indian Rupee is overvalued. It is in fact grossly over valued. So called economists with fancy terms and outlandish theories have never run a business in their lives and have no idea of how the real world works. The value of the rupee should be a function of its relative purchasing power vis a vis other currencies in their respective countries, taking into account their GDPs and per capita incomes. If you take essential food items the Indian rupee is over valued by about 30%, rentals and accommodation 300%, in medical services about 100%, in energy 100%, in petroleum products 100%, in real estate and housing about 1000%, travel and hotels 400% etc etc.

    India’s trade deficit has widened to 14 billion dollars in October. It is expected to zoom further with export industries shutting down in despair after trying to survive against all odds for the past two years against an appreciating rupee. This is no fancy theory. These are concrete facts. Locked gates of thousands of export manufacturers all over India are a mute testament to this unpleasant fact. A poor country like ours with unlimited human resources and willing entrepreneurs should have conquered the world trade had our currency allowed us to compete with the likes of China and South East Asia. For all those ignorant people who have not been to China and keep uttering the names of our two countries in the same breath, let me enlighten you by telling you that China is light years ahead of us in all respects and can be compared to modern developed countries already. Isn’t it ridiculous that Chinese producers are able to ship everything from small consumer products to a full fledged industrial products like boilers to India at a cheaper price than we are able to produce ourselves? Isn’t it the biggest tragedy that lakhs of Indian workers are being sent home everyday from factories shut down as a result of cheap imports? There is one and only one reason for this absurd situation-a grossly over valued rupee. Had the rupee been favorable for trade, today Indian producers would have conquered world trade and the country would have been rich on its own strength, not because of free doles by FIIs. FIIs have invested more than 500 billion dollars in this country? Till date they have taken away a measly 13 billion and our whole economy has floundered. Why? Because we were busy shutting down our own industry and promoting Chinese and our focus is on making quick, easy money from shares and derivatives instead of working hard for the money, like our ancestors.

    Anybody who waxes eloquent upon the value of the rupee and advocates its appreciation should be given a tour of some important countries in the world in which they study what currency value really means. In China, a worker who makes the equivalent of 120 dollars in a month can actually afford to buy a one room tenement in installments. in India a worker who gets 5000 rupees a month (120 dollars @ 40 rupees to a dollar) can barely buy dal and roti for himself and his family. Forget about contingencies like disease. A good 5 star hotel room in the US where average per capita income is nearly 150 times ours, costs 100 dollars to 200 dollars. Now with our distorted currency value that would mean 4000 rupees to 8000 rupees. Tell me where can you find a clean room in a good hotel in a major city in India below 15000 rupees? Why is an acre of the cheapest agricultural land in India worth 15000 dollars and in Canada worth 1000 dollars? Why does a house in a good location in New Delhi cost 5 Million Dollar and a luxury apartment in new York only 1 Million? Are we richer than the Americans and Europeans and Americans already? Sorry, we are not. There are thousands of other examples where relative values can be compared and every time the real value of the rupee will come out in the dumps.

    The results are there for everybody to see. Things will worsen if a sudden devaluation of the rupee by at least 80% is not done.

    The real strength of a country comes from its farmers and its industries, not from a few jokers playing around in the Stock Exchange, wishing for FII doles, artificially propping up the rupee for their nefarious purposes.

    Comment by Gill — December 23, 2008 @ 4:46 pm

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