InvestorQ : Is it true that the level of retail inflation impacts the value of the rupee?
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Is it true that the level of retail inflation impacts the value of the rupee?

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3 years ago
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The understanding of inflation is the key to understanding the real effective exchange rate (REER). The REER is a barometer of whether the currency in question is overvalued or undervalued. While the actual calculation is quite complex, there is a very simple rule that needs to be understood. For example, if India’s rate of inflation is 6% and the US rate of inflation is 2%, then the Indian rupee must depreciate each year by around 4%. If it depreciates less that that then the rupee will be overvalued and if depreciates more than that then the rupee will be undervalued. For example if the INR has a REER of 117 then it means that the INR is overvalued to the extent of 17% vis-à-vis the US Dollar. In the Indian context, retail inflation is measured by CPI inflation or the consumer price index and the RBI has been successful in stemming inflation under the 4% mark in the last few months.

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