Annual Economic Survey and USDINR. New REER Indexes and Excess RBI Capital

NEW REER Indexes

As per the annual Economic Survey 2016-17, released on 30^th Jan 2017, INR overvaluation is overemphasized by the IMF REER and RBI REER, as it places undue weights on Euro and AED. The report goes on to make two new indexes for measuring INR valuation calling it Asia H and Asia M. Both these indices focus on India’s manufacturing trading partners and simultaneously on countries who have increased their global manufacturing export share from 2010 to 2015. This has been done to come up with an index which measures INR valuation against countries with whom India actually competes for its trade share. These indexes give a 44% and 31% weight to the Chinese Yuan (as compared to ~11% in the other REERs). As of Oct 2016 both these indexes (ASIA H and ASIA M) are under 105.

The report goes on to say that INR has not lost competitiveness as much as previously thought and therefore we can assume that accelerated INR depreciation might not be a policy (this is in contrast to my earlier assumption).   

Excess RBI capital

Interestingly the survey seems to make a case to use the excess RBI capital to extinguish government debt or recapitalize PSU banks (pg99). The survey states that RBI is one of the highest equity central banks in the world. A closer look at the RBI annual report and accounting methods show that the free capital (as on 30^th June 2016) apart from issued notes (Rs. 17 lakh crores), CRR (Rs. 5 Lakh crore) and contingency fund (Rs. 2 Lakh crore), is sitting in Currency and Gold Revaluation account (CGRA) of Rs. 6.5 lakh crore.

This revaluation is nothing but the notional gains that RBI has recorded because of INR depreciation over the years. RBI is a dollar asset heavy entity which gains when INR depreciates. Thus if INR appreciates to let’s say 60.00 then this account would record a notional loss of Rs. 2.4 lakh crore (10% of total FX reserves of Rs. 24 Lakh crore / USD 360 billion). Now I would conjecture that if the government is eyeing these notional gains as a means to improve fiscal health then any chance of significant INR appreciation is out of scope going forward. 1% INR appreciation would contract RBI capital by Rs. 24 k crore and would indirectly affect RBI’s ability to declare dividends for the government.

Thus while significant or accelerated INR depreciation is not something that seems to be on the government’s agenda, substantial INR appreciation from the current levels also looks unlikely. These observations would make me revise my yearly range on USDINR from 67-71.50 to 66.50-70.00 for the CY 2017.