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Rupee Reprieve Could Prove Temporary

INR

Spot USD/INR stabilized last week around record highs close to 77.50, following reports that the Indian authorities were intervening in the FX market. However, fundamentals still point to meaningful headwinds for the rupee.

  • It's difficult to make the case the INR is cheap from a long term perspective. The first chart below is the INR real effective exchange rate (REER). Current levels sit just below recent cyclical highs and we are only around 3% off record highs.
  • A large driver of the elevated REER for INR is the persistently stronger inflation rate in India compared to the rest of the world. Indeed, it has only been in the last 12 months or so that the rest of the world has seen inflation rates on par with those in India. Over the long term the positive CPI differential India has had with the rest of the world has more than offset INR nominal FX depreciation.

Fig 1: INR FX Still Expensive In Real Effective Terms

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Spot USD/INR stabilized last week around record highs close to 77.50, following reports that the Indian authorities were intervening in the FX market. However, fundamentals still point to meaningful headwinds for the rupee.

  • It's difficult to make the case the INR is cheap from a long term perspective. The first chart below is the INR real effective exchange rate (REER). Current levels sit just below recent cyclical highs and we are only around 3% off record highs.
  • A large driver of the elevated REER for INR is the persistently stronger inflation rate in India compared to the rest of the world. Indeed, it has only been in the last 12 months or so that the rest of the world has seen inflation rates on par with those in India. Over the long term the positive CPI differential India has had with the rest of the world has more than offset INR nominal FX depreciation.

Fig 1: INR FX Still Expensive In Real Effective Terms

Keep reading...Show less