While most EM currencies have come under pressure from dollar strength in Nov-21, the INR has appreciated by 0.7%. INR has also gained against 38 out of 40 currencies in the REER basket in Nov-21. We estimate this relative outperformance of INR to increase its overvaluation on REER basis to 9.4-9.9% in Nov-21, the strongest level in nearly 4-years. Seen from a historical context, the current negative correlation between DXY and USDINR is getting ripe for a reversal. This holds from REER perspective as well, where historical reversals in overvaluation has got triggered in the 8-12% range.
While recent strength in capital inflows is delaying this adjustment, a catch-up with peers is likely in the coming months. Expect strong reserve cover to prevent a tailspin move.
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