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The Indian rupee has remained stable over the course of several years, primarily due to norms put in place by the RBI. However, the volatility of the rupee’s movement is seen clustered around the global crisis period of 2008 and then again during the eventual slowing down of the Indian market economy due to QE programs abroad. The tight regulatory framework of the RBI is what constrained the rupee against the dollar amidst this volatility. Traditionally, the movement was kept by the reserve bank such that it remained within a window where exports became competitive. In contrast, the strength of the rupee today is a result of a strong inflow of capital traded that the rupee is facing due to artificially low interest rates across the globe and excess liquidity.
Source: Trading economics database
Traditionally, the effect on the valuation of the rupee has come primarily from changes in US Fed rate hikes and valuation of the dollar. In recent times however, political uncertainties and policy changes in the Eurozone could also affect the valuation of the rupee. Uncertainty in government formation in countries like France and Germany have directly affected the liquidity generated out of the Eurozone and that in turn could have an impact on rupee valuation. The rupee, thus, runs the risk of depreciation in line with currencies of other emerging economies around the world. The space for appreciation or depreciation of the rupee will depend essentially on the RBI’s intervention policies.
The rupee has remained stable albeit with either upward or downward swings post major crisis and liquidity changes.
Source: Trading economics database
Liquidity changes have mainly been triggered by events such as the dot come bubble, the 2008 crisis or the Eurozone debt or the Russian crisis. However, the rupee is now showing signs of overvaluation, primarily because exports have yet to show a considerable recovery and most of the overvaluation comes from the hot and unstable foreign portfolio investments and carry trade. It thus becomes important to consider a couple of things before valuing the rupee in the future. First, the US federal interest rate and second, the impending taxation amendments that President Trump is proposing. Both would significantly affect the inflow of foreign currency in the Indian market and thus affect the valuation.
Prima facia, it appears that the GDP growth rates haven’t affected the value of the rupee since it has been more or less geared towards global liquidity trends and insert rate movements[4]. However, one cannot take away from the CAD discipline followed by the government.
We ran a simple EGARCH model to understand volatility clustering and find trends for the future and find that rupee would now start entering a phase of high volatility and lower valuations in the future.
Source: Calculations of the Author (from EGARCH model run on the rupee)
Topics: India, Rupee