 (8).png)
3 weeks ago
5
ARTICLE AD BOX
Summary
The current real depreciation is neither unusual nor indicative of extraordinary stress. Over the past 15 years, the rupee has experienced larger real depreciations on at least 16 occasions. What is being witnessed today is well within the range of normal adjustment rather than a signal of crisis.
The recent depreciation of the rupee against the dollar, particularly following the West Asia war, has triggered a familiar wave of concern about external vulnerability and macro stability. This framing, however, rests almost entirely on movements in the nominal exchange rate, which is the wrong benchmark. A look at the real effective exchange rate tells a very different story. The current real depreciation is neither unusual nor indicative of extraordinary stress. In fact, over the past 15 years, the rupee has experienced larger real depreciations on at least 16 occasions. By that standard, what we are witnessing today is well within the range of normal adjustment rather than a signal of crisis.
Before analyzing the data, it is important to be clear about what the real effective exchange rate actually measures. Consider a simple example. Suppose an item ‘X’ costs ₹50 in India and $1 in the US, with an exchange rate of ₹100 per dollar. The real exchange rate is then 0.5, meaning an Indian X is half as expensive as an American X when expressed in a common currency.
Now, imagine that domestic prices rise by 10%, so X now costs ₹55 in India, and the exchange rate moves to ₹110 per dollar. The nominal exchange rate has depreciated, but the real exchange rate remains 0.5. Relative prices have not changed. There is no real depreciation. What matters is whether the exchange rate and domestic prices move differently.
A real depreciation occurs only when the exchange rate adjusts more than inflation, making domestic goods cheaper relative to foreign goods; a real appreciation is the opposite.
In practice, we do not compare the price of one X in India with one X in the US. We compare the price of a broad representative basket of goods and services in India with similar baskets in the countries we trade with, and then aggregate these comparisons across trading partners using trade shares as weights.
The Reserve Bank of India does precisely this through its trade-weighted real effective exchange rate (Reer) index for a 40-currency basket, with 2015-16 as the base year. On that measure, the rupee today has depreciated by about 6% in real effective terms relative to its 2015-16 benchmark. Of course, no such index can be measured with perfect precision. The underlying baskets are imperfect, country weights evolve over time, and comparable prices across countries are never observed cleanly. But despite these limitations, the Reer remains far more informative than the nominal dollar rate for judging whether the rupee is genuinely under stress.
Is this roughly 6% real depreciation unusual? The answer is no. First, consider the RBI data. Using the 2015–16 base year, in nearly a quarter of the observations, the real exchange rate is more than 6% below the base year level. As an alternative source, consider the data published by the Bank for International Settlements, which shows a real depreciation of close to 9.5% for the Indian currency as of February 2026. Here too, more than a quarter of monthly observations over a three-decade period exhibit real depreciations larger than 9.5%. While the RBI data shows a maximum depreciation of about 14%, the BIS data shows a maximum real depreciation of close to 19% over the same period.
Second, and more importantly, the rupee has been on an upmove for most of the last six years, appreciating by as much as 8% as of November 2024. What we are observing now is that this one-sided and prolonged real appreciation is being unwound. Without this background, it is easy to misread the current movement as a sudden deterioration. In reality, this is a correction of an extended period of real appreciation. Markets do not adjust smoothly; they tend to overshoot in both directions, and what we are seeing today fits squarely within that pattern.
Does this mean there is nothing to worry about? No. Even if the level of the real exchange rate is not alarming, volatility itself can be costly. Firms that have borrowed in foreign currency without adequate hedging face an immediate increase in their cost of capital when the nominal exchange rate moves sharply. More importantly, companies do not borrow in a trade-weighted basket of currencies; they borrow in a single currency such as the dollar or the euro. For them, the bilateral movement is what matters, not the Reer. This is where the current episode deserves attention.
The concern is not misalignment, but volatility. And on that dimension, the data suggests that we are approaching levels seen during past stress episodes. Managing this volatility, rather than reacting to the level of the exchange rate, should therefore be the focus of policy. At the same time, there is a deeper issue that cannot be ignored. Foreign investors have been persistently pulling out despite strong expected growth. This points to concerns that go beyond cyclical factors and will require longer-term policy responses aimed at improving competitiveness and productivity.
Dr Prasanna Tantri teaches at the Indian School of Business.
English (US) ·