Rupee volatility matters less than our broader policy target

“It depends on where you want to reach.” – Lewis Carroll, Alice in Wonderland

Rupee . rate has gone 74.51 to US Dollar as on January 1, 2022 82.27 While writing this. This has raised concerns about the volatility of the rupee and the detrimental effects on India’s overall macroeconomic and financial stability, as well as on trade and investment. The Reserve Bank of India has also faced tough calls to protect the rupee. In which direction should the RBI go with the exchange rate?

It is true that around 10.5% depreciation of the rupee against the dollar in the last 10 months is likely to hurt firms and individuals who have to pay in dollars. His concerns with such disorderly movements of the exchange rate are well appreciated. However, the occurrence of depreciation of the rupee against the dollar does not automatically translate into a diagnosis of increased volatility of the rupee with relevant policy prescriptions or expectations.

The volatility of one currency, such as the rupee, refers to the frequency and extent of changes in the value of another country’s currency, such as the dollar. To understand such volatility, one can look at the daily (or annual) standard deviation from the mean, which is a statistical measure of the variation in a set of data that reflects its scatter around the mean. Using this, RBI data shows that exchange rate volatility in the 5-year period 2018-2022 has actually reduced compared to the global financial crisis period of 2008-2012 (bit.ly/3S8USYi).

We compared changes in the volatility of the rupee against the dollar for the period January-October 2021 and 2022 on Yahoo Finance data (yhoo.it/3gaG4v6). We saw a decrease in the volatility of the rupee at the 1-sigma level (single standard deviation) in 2022, while the volatility at the 2-sigma level remained the same. This was also when the rupee-dollar average rate has declined by about 5%.

The dollar-rupee daily rate deviated from the 1-sigma level in 72 days in the January-October 2022 period, compared to 76 days in January-October 2021. Again, while the daily exchange rate exceeded the 1-sigma level in 33 days. During January-October 2022, this number was 40 days in 2021. On the other hand, in both 2021 and 2022, the daily rate exceeded the 2-sigma level in just 5 days. We conclude that the rupee has not fluctuated as compared to 2021. quite bad in dollar terms; If at all, the rupee has exhibited a harmful kind of low volatility in 2022.

Looking at the movement of the rupee against the euro, the rupee has strengthened significantly against the eurozone currency in both calendar years 2021 and 2022, but more so in 2022. Thus, while the rupee has gained about 2.5% against the euro in January-October 2021. It has increased by about 5.8% between January and October 2022. The average euro-rupee has grown at the rate of 87.89 to in 2021 82.13 in 2022.

Turning to volatility, Euro-Rupee daily rates remained above 1 sigma level in 29 days from January-October 2021, while they remained below 1 sigma level in 41 days, indicating an appreciation. In 2022, the euro-rupee rate remained above the 1-sigma level for 40 days, while it remained below 1-sigma for 39 days. The total days of divergence were more or less the same over the two years. Volatility has reduced at the 2-sigma movement level, with the Euro-Rs rates deviating from the 2-sigma level by more than 7 days in 2021 compared to 1 day during January-October 2022. Then, thus, we can conclude that there is no significant reduction in the volatility of the rupee in terms of Euro as compared to 2021.

While volatility has not increased dramatically in 2022, what about concerns of rupee depreciation? The fact is that the Indian rupee is currently worth more than the basket of our six major trading partners and 40 partners with whom we do bilateral trade. Thus, the 40-currency trade-weighted basket of real effective exchange rate (REER) for August 2022 stood at 103.86, while the six-currency basket (trade-weighted) stood at 103.77. 100 or closer to 100, the currency is considered to be quite valuable. With India’s imports being more than its exports, it is okay to value the currency slightly higher, say in the range of 103-104. However, the demand for major intervention by the country’s central bank to check the depreciation of the rupee against the dollar or the destabilization of the rupee is wrong.

The third concern expressed is about the reduction in ‘precious’ foreign exchange reserves to contain the volatility of the rupee. The key point here, however, is that the net draw-down of India’s reserves is much lower than the headline figure reported in terms of valuation deficit. Also, the decline in foreign exchange reserves as a proportion of the total during the current episode of foreign exchange management due to this year’s Russia-Ukraine conflict and US Fed policy tightening compared to what happened during the global financial crisis. Size is too small. ,

If India aims to move towards being a part of a globalized world, the move of the rupee should be treated as such a necessary evil. There is no room for false paranoia when it comes to exchange rate management.

Tulsi Jayakumar is Professor of Economics and Executive Director, Center for Family Business and Entrepreneurship, SPJIMR of Bhavan