Why in news?
The Indian rupee's sharp depreciation over the past one-and-a-half years has transformed it from an overvalued currency into one that is now more undervalued than even the Chinese yuan — potentially boosting India's trade competitiveness.
What’s in Today’s Article?
- Recent Rupee Movement
- Understanding Effective Exchange Rates
- From Overvaluation to Undervaluation: The Data
- More Competitive Than the Yuan
- Conclusion
Recent Rupee Movement
- Hardening global oil prices, following renewed US-Iran hostilities, pushed the rupee past 96-to-the-dollar on July 14, where it stayed until July 24.
- A pause in daily strikes since has strengthened the rupee to around 95.9, as Brent crude eased below $85 per barrel after surging past $95 on July 23.
- The rupee hit an all-time low of 96.96-to-the-dollar on May 20, while Brent crude had crossed $126.4 per barrel on April 30.
- RBI Governor Sanjay Malhotra noted the rupee has become undervalued and could appreciate once the West Asia situation stabilises, as seen in past episodes of external shock-driven volatility.
Understanding Effective Exchange Rates
- NEER (Nominal Effective Exchange Rate) and REER (Real Effective Exchange Rate) are the key indices used to measure whether a currency is over- or under-valued.
- These indices track the rupee's movement against a basket of 40 currencies of countries accounting for about 88% of India's trade flows, with 2015-16 as the base year (value = 100).
- Currency weights are derived from each country's share in India's total foreign trade — similar to how the Consumer Price Index (CPI) weighs commodities by consumption share.
- NEER captures the rupee's external value against this basket without factoring in inflation.
- REER adjusts NEER for inflation differentials between India and its trading partners — making it the true measure of a currency's value.
- If Indian prices rise faster than trading partners' even with a stable exchange rate, REER rises, making Indian products less competitive globally.
From Overvaluation to Undervaluation: The Data
- In November 2024, the REER of 108.03 meant the rupee was over 8% overvalued in real terms.
- By June 2026, the REER of 91.26 represents an 8.7% "real" weakening — confirming the rupee has moved from overvaluation to undervaluation.
- Notably, the REER stayed above 100 until July 2025, marking a clear and relatively recent shift.
- Future appreciation toward "fair value" (REER of 100) depends on sustainable easing of West Asia tensions, reopening of commercial shipping lanes, and absence of new geopolitical energy shocks or US trade actions.
More Competitive Than the Yuan
- An independent measure — the Real Broad Effective Exchange Rate (RBEER), compiled by the Federal Reserve Bank of St. Louis — corroborates this trend.
- RBEER compares a country's currency value against 64 trade partners, using 2020 as the base year.
- The rupee's RBEER fell from an all-time high of 106.1 (November 2024) to 90.15 (June 2026).
- In November 2024, the yuan's RBEER (92.16) made it more undervalued and competitive than the rupee.
- By June 2026, the yuan's RBEER (92.24) was higher than the rupee's 90.15 — meaning the rupee is now a more competitive currency than the yuan.
Why This Matters?
- A more undervalued currency can theoretically:
- Boost the price competitiveness of Indian exports in global markets.
- Make domestic manufacturing more competitive against imports.
- However, whether these theoretical benefits materialise in practice remains to be seen, as several other factors — global demand conditions, supply chains, and trade policy — will also shape outcomes.
Conclusion
The rupee's transition from an overvalued to an undervalued currency — now more competitive than even the yuan — marks a significant shift with potential trade advantages for India.
Yet, translating this currency competitiveness into tangible export growth and stronger domestic manufacturing will depend on global geopolitical stability and India's ability to capitalise on the opportunity.
