Understanding the Rupee's Relative Gain

In a recent report published by the Reserve Bank of India (RBI), it was highlighted that the Indian Rupee has seen a relative gain against the dollar, especially when compared to other currencies. This phenomenon is attributed to the Real Effective Exchange Rate (REER) index, which indicates an overvaluation of the rupee in November as other currencies depreciated more significantly against the dollar.

The Impact on India's Trade Balance

The RBI report suggests that while a weaker rupee benefits India's trade balance in the short term, a stronger rupee is more advantageous in the long run. The trade balance, which is the difference between exports and imports of goods and services, is significantly influenced by the currency's strength.

REER and Its Importance

The REER index, which measures the country's currency against a basket of other currencies, has shown an increase from 90.9 to 91.8 in one month for the 40-country trade-weighted index, and from 104.4 to 105.3 for the six-currency basket. This rise is partly due to the dollar's strength following the US presidential election and India's rising productivity in the tradable goods sector.

The report emphasizes the need for policymakers to be aware of the asymmetric and time-varying impact of REER changes on the trade balance. Additionally, the importance of monitoring REER fluctuations for financial stability cannot be overstated, as significant deviations in the index can precede financial crises.