RBI rate hike or massive deposit mobilisation: what does the 'undervalued' rupee need?
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500+ questions on Economy with explanations
📌 Summary:
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RBI's Monetary Policy Committee (MPC) began its 3-day meeting Wed; repo rate widely expected to stay at 5.25%, but a vocal minority predicts a hike to defend the rupee and pre-empt inflation upside
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Rupee has fallen >10% vs US dollar over the past year; RBI has used FX spot/forward sales, swap windows, auctions and tighter norms on speculative bets to stem the slide
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Governor Sanjay Malhotra calls the rupee "undervalued": its Real Effective Exchange Rate (REER) fell to 90.96 in April (lowest since Sep 2013), implying it is ~9% undervalued against a 40-currency basket
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2013 lesson: rate hikes did NOT defend the rupee; what worked was raising Foreign Currency Non-Resident [FCNR(B)] deposits ($26 bn mobilised). A repeat now would need $50-60 bn and is costlier as global rates are higher
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Risk flagged (Nomura): large rate hikes to defend FX weaken growth prospects and trigger MORE capital outflows
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Root cause is subdued capital inflows: net FDI+FPI is -$18.4 bn since April 2024; FDI has slowed for years as the near-zero global rate era (pre-2022) that flooded EMs with capital has ended
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CEA V. Anantha Nageswaran & JPMorgan's Sajjid Chinoy argue post-2010 foreign investors lacked an India-specific reason to invest — so calling the rupee "undervalued" on old REER may be misleading
🎯 UPSC Relevance: GS3 Economy — exchange rate management, monetary policy, capital flows, BoP; links RBI's policy toolkit to external-sector vulnerability
📝 Prelims Facts:
- REER measures a currency against a basket of 40 currencies; below 100 = undervalued, above 100 = overvalued
- FCNR(B) = Foreign Currency Non-Resident (Bank) deposits, used in 2013 to defend the rupee
- Repo rate currently 5.25%; MPC is a 6-member body
🔑 Key Term: Real Effective Exchange Rate (REER) — trade-weighted average of a currency's value against a basket of partner currencies, adjusted for inflation differentials; a gauge of external competitiveness.
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