The ascent of the rupee

I am amazed that few people are talking about it, and I certainly don't see enough noise being made about it. If the dollar-rupee parity were 12 per cent undervalued, I am sure that it would be on the cover page of Femina. Let's start at the beginning. Raghuram Rajan used to say often that cycles of rupee overvaluation have always led to a subsequent currency crisis. This was seen thrice in recent memory, in 2008, followed by 2011, then 2013. Each time, the rupee went into a cycle of overvaluation about 12-15 months prior to the crisis. Rajan used to insist that these carry trading flows (my words, not his) caused mayhem when they reversed and that banks should be hedging most of their clients' dollar payables, against which India Inc was hedged only about 15 per cent of its total payables. In 2014, he said clearly that he was comfortable with the rupee trading at 60-62.5 against a real effective exchange rate (REER) of Rs 60 in 2014, the time of the first 'Modi Mania', in May 2014. If we add structural inflation differentials to that, moderated by estimated productivity growth (of around 1.5 per cent), we find that the rupee is way overvalued. Based on a simple interpretation of the trajectory of differential inflation vis-a-vis the dollar, most analysts were projecting Rs 69-70 as the target value of the dollar-rupee exchange. Not a single analyst saw the coming mayhem, when the rupee would appreciate almost 9 per cent from those levels, this at a time when the Chinese yuan is at 6.9, up 9 per cent from its pre-crisis level of 6.3. So who is correct, the market or the analyst? Let's examine how this happened, and what it indicates. Most of the money came bunched up, with a spe

This article was originally published on June 07, 2017.