The rupee fell to a 21-month low against the US dollar this week. Pressure on the equity market and some outflows from the bond market pushed the rupee to levels last seen in September 2013. However, this is only half the story.

Even though the rupee has weakened in recent weeks, it continues to outperform its peers, which means that it remains on the overvalued side. The comparative data of emerging market currencies makes this point quite clearly.

Since the start of 2015, the Indian rupee had fallen by about 1.6% till 18 June. This puts the rupee in the top performers list of emerging currencies for the year. Only a handful of currencies have done better. Among them is the Russian rouble, which has gained 12.19%, as it stabilizes after a steep tumble last year. Others that have done better than the rupee include the Taiwanese dollar, which is up 2.4%, and the Philippine peso, which is down 0.8%.

Most currencies that the rupee is typically compared with have all depreciated more than the Indian currency. The Thai baht and the Korean won, for example, are down 2% each, while the Malaysian ringgit and the South African rand are down 6% apiece. The Indonesian rupiah, which is considered the closest comparative currency, is down 7%.

The rupee’s outperformance in 2015 is just an extension of a trend that set in last year. In 2014, we saw the rupee losing just 2% in value despite a sharp rally in the US dollar. This was on par with the Indonesian rupiah but most other emerging market currencies had fallen even more.

What this means is that the rupee continues to be an outperformer. This is good news, as well as bad news.

The good news is that the strength in the currency is reflecting steady economic fundamentals. At home, we have heard a lot of noise about disappointment in the government’s reform process and the fact that growth is not picking up fast enough. But from a global perspective, growth rates above 7% still remain enviable. Another big positive for India—from an investor standpoint—is the fact that inflation in India finally seems to be coming under control. Yes, there are short-term upside risks, but the central bank seems fairly confident that it will meet inflation targets for the year.

India’s external position is also mostly comfortable. The latest round of balance of payments data showed the current account deficit at 1.3% of gross domestic product (GDP) in 2014-15. This is likely to widen this year, but hopefully nowhere close to the all-time high of 6.7% of GDP in the October-December 2013 quarter. The $350-billion foreign exchange reserve pile built-up over the past two years adds an additional buffer.

That is the good news. The bad news is that the outperformance of the rupee leaves it relatively overvalued and potentially more vulnerable to downside risks in the event of global turbulence.

According to the latest data from the Reserve Bank of India (RBI), the 36-country real effective exchange rate (REER) index is still showing some overvaluation, although this has reduced compared to previous months. In May, the REER index was at about 109 levels, compared with 112 in April. Given that historically the REER remains close to 104-105 levels, the current index suggests about a 5% overvaluation.

A relatively overvalued currency does not help at a time when exports are already weak due to low global demand. The latest export data showed a 20% year-on-year contraction in May, extending months of weak performance. However, the currency value is not completely out of line and is only one factor in the export performance. In a recent interview, RBI governor Raghuram Rajan had noted that he is “not unhappy" with where the rupee is.

The second concern over the outperformance of the rupee is the correction of that outperformance. If the global markets turn turbulent after the US Federal Reserve starts raising rates, the rupee may be more vulnerable if it is seen as overvalued and if foreign investors choose to lock in gains in anticipation of a weaker currency. Of course, the RBI has enough reserves now (over $350 billion), which it will likely use to put a floor under any sudden and volatile correction in the currency.

Away from the levels of the rupee, the return of some volatility and two-way movement in the foreign exchange markets is actually healthy. The steady band within which the rupee was moving last year had lulled companies into complacency and many had stopped hedging their overseas exposures. Despite repeated warnings and efforts from the central bank, the hedge ratio had fallen as companies saw little reason to take on the additional cost of hedging given that the rupee was range-bound. The return of some volatility could push companies back towards hedging more actively.

Ira Dugal is assistant managing editor, Mint.

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