ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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How Far Is India’s Nominal Exchange Rate from Equilibrium?

How Far Is India’s Nominal Exchange Rate from Equilibrium?

The swings in the Indian nominal exchange rates, associated with global events, are driven more by surges in global capital. No evidences of systemic overvaluation are revealed. In fact, the Indian equilibrium nominal exchange rate has depreciated since 2012, despite real appreciation, but the range of ₹ 68–₹ 71 per dollar was close to the equilibrium in 2018.

 

A strand of literature pointed to undervalued exchange rates in emerging market economies (EMEs), especially in China, as responsible for global current account imbalances and build-up of risks that resulted in the global financial crisis (GFC) (Blanchard and Milesi-Ferretti 2012). But there is an alternate view that large cross-border flows due to under-regulation and excessive leverage affected exchange rates (Goyal 2009). Investments in the United States (US) bonds due to dollar strength encouraged overconsumption in advanced economies (AEs) (Dooley et al 2004; Gourinchas et al 2012). Similarly, the slowdown after the crisis led to the “currency wars” hypothesis that countries were trying to support their own exports through currency depreciation. The alternative hypothesis is that surges and sudden stops in capital flows due to global risk-on, risk-off and quantitative easing (QE) affected exchange rates (Rey 2013). If the trade-related mercantilist view is correct, exchange rates of key EMEs should have been undervalued both before and after the GFC. If EME exchange rates are found to be largely overvalued, the alternative hypothesis of excess global leverage and liquidity would be more valid.

Estimating ERER

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Updated On : 16th Mar, 2020

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