- UPSC Syllabus Tags: GS Paper III—Indian Economy and issues relating to growth and development
- Context: The article examines why India’s real effective exchange rate has moved from overvaluation to undervaluation and what this means for exports, imports and inflation.
- Source: “The rupee is no longer overvalued: Why this may help India,” The Indian Express, July 29, 2026.
Economic Context
- India’s 40-currency effective-exchange-rate basket covers trading partners accounting for about 88% of its trade.
- With 2015–16 set at 100, REER fell to 89.08 in May 2026 and recovered to 91.26 in June.
- The June value represented approximately 8.7% real depreciation from the base-year level; REER had remained above 100 until July 2025.
Essential Context
- A bilateral rupee–dollar rate does not capture movements against all major trading partners.
- Domestic and foreign inflation can change competitiveness even when nominal exchange rates remain constant.
- Currency depreciation influences trade alongside productivity, logistics, tariffs, global demand and the import content of exports.
Key Terms
- Nominal Effective Exchange Rate: A trade-weighted index of the rupee’s nominal exchange rates against a basket of partner currencies.
- Real Effective Exchange Rate: NEER adjusted for relative inflation between India and its trading partners.
- Exchange-rate pass-through: The extent to which depreciation raises domestic prices through costlier fuel, machinery, components and other imports.
Why It Matters
- A lower REER makes Indian goods relatively cheaper and may support exports and domestic production competing with imports.
- Import-intensive exporters may face higher input costs that offset the currency advantage.
- Weak global demand, foreign tariffs and inadequate production capacity can prevent favourable prices from producing larger sales.
- Depreciation raises the rupee cost of oil and may increase inflation, external-debt servicing costs and input subsidies.
- RBI intervention generally seeks to manage excessive volatility rather than maintain a permanently undervalued currency.
Prelims Focus
- NEER incorporates nominal exchange rates; REER additionally incorporates relative prices.
- An index below 100 indicates depreciation from the base period, not necessarily undervaluation relative to an estimated equilibrium rate.
- Bilateral depreciation need not produce an identical NEER movement because other currencies also change.
- Depreciation can improve export pricing while increasing imported inflation.
Mains Relevance
GS Paper III—Indian Economy
- Exchange-rate competitiveness must be evaluated alongside inflation, productivity and external stability.
- Industries with higher domestic value addition may benefit more than import-intensive exports.
- Energy security and diversified supply chains reduce the inflationary cost of depreciation.
Mains Answer Enrichment
- Dated evidence: REER was 91.26 in June 2026, compared with 108.03 in November 2024.
- Balanced formulation: A competitive exchange rate can support trade but cannot substitute for productivity and reliable market access.
- Reform: Combine exchange-rate flexibility with energy diversification, export logistics and deeper domestic component production.
India’s Exchange-Rate Competitiveness
India’s exchange-rate competitiveness depends on how the value of the Indian Rupee affects the international prices of its exports and imports.
Economists and policymakers mainly assess exchange-rate competitiveness through the Real Effective Exchange Rate (REER). It measures the value of the rupee against a trade-weighted basket of currencies after adjusting for inflation differences between India and its major trading partners.
REER and NEER
Nominal Effective Exchange Rate
The NEER shows the average nominal value of the rupee against a basket of trading-partner currencies. The rupee has generally depreciated gradually in nominal terms over time.
Real Effective Exchange Rate
The REER adjusts the NEER for differences in inflation. When inflation in India is higher than inflation in its trading partners, the REER rises.
Currency Overvaluation
A REER index above the benchmark level of 100 indicates overvaluation. This makes Indian goods relatively more expensive in global markets.
RBI’s Managed Float Policy
Managed Flexibility, Not a Fixed Rate
The Reserve Bank of India intervenes to moderate excessive currency volatility while allowing the rupee to respond to wider market conditions.
Exchange-Rate Management
The Reserve Bank of India intervenes in the foreign exchange market to reduce excessive volatility rather than maintain a fixed exchange rate.
Benefits
This policy helps build foreign exchange reserves, protects the economy from external shocks and stabilises import costs.
Trade-Off
During periods of high domestic inflation, preventing a sharp depreciation of the rupee can keep the REER high. This may reduce the price competitiveness of manufacturing exports.
Sector-Wise Impact
| Sector | Exchange-Rate Sensitivity | Effect of an Overvalued or Stronger REER |
|---|---|---|
| Labour-Intensive Manufacturing Textiles, leather and gems | High | Indian products find it harder to compete on price with countries such as Vietnam and Bangladesh. |
| Services and Global Capability Centres IT, consulting and research and development | Moderate to Low | These sectors remain relatively resilient because their competitiveness depends more on skills and high value addition than on currency margins alone. |
| Import-Dependent Industries Electronics, energy and capital goods | High | A stronger rupee lowers the cost of imported raw materials and equipment. |
Import–Export Trade-Off
Import Dependence
- Energy Exposure: India imports more than 80% of its crude oil needs.
- Industrial Inputs: India also imports large quantities of electronics, fertilisers and machinery.
Inflation Transmission
- Imported Inflation: A rapid depreciation of the rupee raises the cost of imported goods and inputs.
- Cost-Push Effect: Higher import costs increase domestic inflation and may reduce the export advantage created by a weaker rupee.
Price and Non-Price Competitiveness
Currency and Prices
Exchange-rate movements directly affect the international prices of Indian goods and services.
Logistics and Infrastructure
Better ports, freight corridors and road networks reduce transport time and supply-chain difficulties.
Global Value Chains
Lower import tariffs on intermediate goods help Indian manufacturers participate in global production networks.
Ease of Doing Business
Simpler land acquisition, labour compliance and trade-clearance procedures may provide greater efficiency gains than currency depreciation alone.
Exchange-rate depreciation can improve price competitiveness, but sustainable export performance ultimately depends on productivity, infrastructure, efficient regulation and deeper participation in global value chains.
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