A currency with an exchange rate lower than it ought to be is undervalued currency. A currency may be undervalued when its purchasing power, supply and demand are all strong, but still its price is comparatively low.
The rupee has been falling sharply over the past couple of months prompting experts to say it is now overshooting. A currency is said to be valued fairly if the REER (six currency index) Index is close to 100. When REER goes above the 100 mark, the currency is termed to be entering over valued zone and when it goes below 100, it is said to be entering the under valued zone. But these assumptions work when one is looking at the long term performance of the currency and not on monthly basis.
In current situation it is pointless to assess the currency’s fair value through REER as it tends to overshoot on both sides.
According to Legendary investor Joseph Benhard Mark Mobius, the country should focus on increasing productivity and ensuring investments in the right areas to counter inflation and boost the undervalued rupee. He said one of ht reason of undervaluation of rupee is poor policy and investment environment. If that is rectified, rupee can once again be stable. India should also follow China for appreciating currency. China has been able to appreciate its currency through improved productivity.
The rating agencies in the World will look at the current environment and could take an action based on the current prospects. It may downgrade India’s ratings.
According to Finance Minister also rupee is undervalued.
But for rectification, India has to change policies and has to work on continuous improvement of production.