Falling Rupee: Has the Rupee depreciated beyond its fundamental value?

The exchange value of currencies are fundamentally to be driven by their Purchasing power. One basket of identified goods and services costs $10 and the same basket costs Rs.400 , the exchange rate is $1 =400/10= Rs.40. When the inflation in each countries are different, the movement depends upon the differential inflation rate. Suppose the same basket of goods and services after 1 year costs $10.5 and Rs. 500 , then exchang ration could be $1= 500/10.5 = Rs.47.61. Since the inflation in US is under 2% in the last 3 years, and average inflation in India is over 10% in the same period , the depreciation of indian currency should be 8% per year (10-2) and for 3 years 24%. Where as the rupee depreciation is in the same range. But one more variant of this is, the supply and demand which determines the exchange rate. If the FII increased substantially, the rupee may appreciate inspite of the higher inflation. Hence there is no sure way of determining the correct exchange rate.

Yes, we are touching historical lows and it is definitely below it`s fundamental value. When we started reforms in 1991 and had depreciated our currency it was around the same level, since then only briefly we had come close to this level in Dec 2011.

The RBI and the Govt need to proactively resolve this issue by ensuring investor friendly policies so that dollars start flowing back into our economy and stem the fall of our currency.