The past two weeks have been disastrous for the rupee value against dollar currency. The same time last month (22-Aug-2011), rupee value against dollar was 44.5 – 45.0 range, at this time of writing this article it is hovered to the range of 49.0 – 50.0. It is expected to raise further which would result in weakening the rupee value against the dollar currency. This kind of increase would have the drastic impact on the macro economy of the country like heavy raise in the import cost where countries like India heavily depends on the importing on Oil and other crucial raw materials needs for the industries.
This article explores the reason behind the rupee value depreciation, how RBI trying to defend the rupee value and how it is going to affect the industries. I come up with this article after the readers request to understand the currency war on recent days. If you have any thoughts, please post it in the comments section. Subscribe to our future articles here.
also read:
How currency value is determined?
We are not going deep dive into economic terms to understand the currency value fluctuation. There are many factors to decide the currencies values but that could be very difficult for the common man to understand the theory. Here I will put it in the simple words why the currency value is often fluctuated. A currency will tend to become more valuable when its demand is higher than supply. A currency will tend to become less valuable when its demand is less than supply. It is the basic theory. We need to understand in the global economy terms, when the currency will have more demand and when it will have less demand.
Remember that exchange rates are expressed as a comparison of two currencies. It is always relative and can be measured between two countries. Interest rates, Inflation and exchange rates are highly related. Reserve bank change the interest rates to control the Inflation and exchange rates.
We can take our real time example of stock market investment to understand the above principle. As we know that, our stock market is dominated by the overseas investors (outside India), because of the our growing economy and industrial development. When our economy is doing well and market is performing better than other countries, overseas investors would invest heavily on our market. How they would put it in our market?. They will sell or convert to our currency and invest in India. It is clear that when more investors coming to India, the demand for the currency will be very high. Our rupee value will be increased against dollar. In the same way, when they are pulling out of market, demand for the rupee will be decreased and value is depreciated.
Here I am talking only about the dollar, because it is the global currency and most of the countries trading using the dollar as trade reserve currency. The above example is given to explain it in simple words, the demand for a currency would come in the different way. When we are importing from other countries, we should have the currency of that country to pay for the trade. The value for the currency is fluctuated on real time.
If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly on financial markets, mainly by banks, around the world. A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan renminbi (CNY, ¥) was pegged to the United States dollar at ¥8.2768 to $1.
Why RBI intervene on Currency valuation?
In the last week we have seen RBI has acted to stop the erosion of rupee value against the dollar currency. What it did was sold the dollar currency in the market to increase the value of rupee. But, it is very difficult for the Reserve Bank of a country to adjust the value of the currency, the long term solution would be fix the problem in economy and bring the inflation into control. You would wonder why RBI has to intervene on currency value decrease or increase. Note that, RBI would not allow currency to be higher after certain level because of the exports would get affected like IT companies would suffer if the rupee get appreciated against the dollar.
India is heavily depend on the import of raw materials and Oil for its industrial development. In the decreasing rupee scenario, the outgo of money will be much higher. This would affect the expenses for the companies who imports raw materials for their factory and all the Oil Marketing Companies (OMC) will incur heavy payment to import the Oil. Now you would have understood why the Petrol prices have been increase in the last fortnight. If you look into the news papers, the reason said by our finance minister was the depreciation of rupee value against dollar.
Major Factors Influencing the Currency Value
In the above section, I have explained in the simple words to make a common man understand the currency fluctuations. This sections write down few economic conditions when the currency value will be under pressure.The following are the three major factors influencing the changes in the currency values. There are many other factors too, but we are not talking about all the factors in this section.
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Inflation
- As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies (What is Inflation?).
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Interest Rates
- A higher interest rates offer good returns compare to other countries. It will result in the foreign capital come into the country. Lower interest rates decrease the currency value. Note that interest rates has the close relation with interest rates. The currency value would not be affected only based on the interest, it is impacted based on the other conditions like inflation or economic situation.
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Current Account Deficits
- Basically current account of a country presents the status on the trade of a country between other trading partners. If there is any deficit in the current account, that means country is doing more trading outside the country then its actual earning inside the country. This situation is not good for a country because the country needs to buy more foreign currency to fulfill its need inside the country. A country needs to manage its deficit within control, otherwise it will lead to a economic problem. More demand for the foreign currency would reduce the value of that country’s currency.
Impact of INR vs USD
In the last two weeks Indian rupee has depreciated about 7% against the USA dollar value. It is expected that it would continue the slide as many macro economic factors not in favor of Indian economy. The following are the factors which would slide down the rupee value.
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Foreign Funds Outflow
- It is the major concern of Indian economy now. Because of the global uncertainty and various economy crisis like Europe sovereign debt problem, US economy problem, etc leads to search for the safe heaven among the investors. They are quickly pulling out the money fro Indian market and investing in any other safe investments like Gold or US dollar.
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Government Deficit is High
- The government finances are in a bad shape and the combined central and state government deficit has stubbornly stayed around 10 per cent of GDP. It is high deficit and investors lost faith in the local economy.
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Political Uncertainty and Corruption
- This is one of the major factor for any country to stabilize the economy. In India, last one year we are seeing the series of corruptions and there is no good news from the ruling party (Congress) about the economic reforms and lot of agitation among the citizens including the veteran Gandhian Anna Hazare’s campaign of Fight for Second Freedom which took attention from global media. India needs political change to gain confidence among the investors.
Summary
Updated (29-June-2012):
The rupee value against dollar is around Rs. 57. It is expected that it will go further down in the coming days. The latest new reveals that India is in recession. The govt. data provided on the GDP is not correct, there is mismatch between the various sources released data. According to the real data, India’s growth is in the negative trend. We are moving back to the olden days. Please read this article.
Understanding the currency basics is not as simple as reading this article. This article provides the very basic details about the India’s situation and devaluation of rupee in the recent time. If you would like to understand the different currency market in the world, please read the book Currency Wars. It is one of the best seller in the subject of the currency market.
I hope this article would have given an idea about the rupee depreciation and the reason why the currency is changed. But, there are hundreds of parameters to decide a currency value and politics also there to manipulate the own currency which China has done for a long time. The above are the very basic idea on currency value and how it is affected. If you have any thoughts, please post ti in the comments section.
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September 25, 2011 at 7:22 am
This was very article sir….!
but i want more precise information about the factors deciding the value of currency and also the measures that can helps India to appreciate against dollar.
As per article this is for common people but please write for the people who are from finance background….
September 25, 2011 at 8:34 am
Hello Rahul Ghegadmal,
Thank you for the comments. Yes, the intention of the article is to make common man have some basic ideas on the currency values. Most of the finance guys would have the fair idea on the concepts. Certainly I will come up with the more detailed article in future.
Coming weeks I will be writing about the slow down on global economy and the recent burning issues.
Thanks,
Krishna
September 25, 2011 at 11:24 pm
Great Article. A must read for a naive junta.
September 25, 2011 at 11:54 pm
Good article. Thanks. New information for me in this article is the “Interest Rates” impact on currency.
I have few dollers which i am not using for long time. Is it good time to convert to Rupee and keep the amount in fixed deposit or wait for few more days?
I have small doubt on RBI policy on making higher interest to consumer to control inflation. The RBI’s intension is to curtal demand. However for those people who are already taken loan, will it not actually increase their expenses(or rather say – inflation)?
September 26, 2011 at 1:59 am
Dear Sir ,
Your Article’s are very very nice , usefull & heplfull for us to know about Finance (doubts). Kindly can you give briefly about Macro & Micro economic subjects.
Thank You
S. Prakash
September 26, 2011 at 8:20 am
Hello Irshad,
Yes. There won’t be much depreciation in the USD vs Dollar since its already gone through. You can convert it now.
To control the Inflation, hiking the interest rates is not the only solution. Even RBI governor knows it, but he has nothing else can do because finance minister controls him. Without government’s co-operation it is not possible to control the inflation.
Thanks,
Krishna
September 26, 2011 at 8:22 am
Hello Prakash,
Thank you for the suggestions. I will soon come up with the topic Macro and Micro economics.
Thanks,
Krishna
September 26, 2011 at 11:43 am
The info. u provide is really great and helpful to understand basic concepts.Plz keep posting such articles.
Thank you.
September 26, 2011 at 7:06 pm
Hello Mahesh,
Thank you for the comments.
- krishna
September 27, 2011 at 9:35 am
thanks for the artciles .
but sir u talked about how currency fluctuate with demand and supply but sir plz explain how pegging works n is it legal(fair) on part of country doing the same. and sir in article u talked about that foriegn investor are moving for safe haeaven for their investment . can u plzz name some economy which is showing for strength than india, usa,n euopean country..
once again thanks sir .. n plz post more articles of such important..
September 27, 2011 at 9:36 am
thanks for the artciles .
but sir u talked about how currency fluctuate with demand and supply but sir plz explain how pegging works n is it legal(fair) on part of country doing the same.
September 27, 2011 at 9:37 am
and sir in article u talked about that foriegn investor are moving for safe haeaven for their investment . can u plzz name some economy which is showing for strength than india, usa,n euopean country..
once again thanks sir .. n plz post more articles of such important..
September 27, 2011 at 9:58 pm
thanks a lot you all..i was looking for the same info..
September 27, 2011 at 9:59 pm
Hello Rahul,
Few countries doing the currency pegging to stabilize the trade. For example, even China has set the fixed rate of Yuan and not allowing to raise against the Dollar currency to get benefits of the exports. It will be good only when both the countries happy with that. Otherwise it is not good to manipulate the currency.
We can not say any specific economy which is strong at this point of time. We need to wait and see after the global slow down.
Thanks,
Krishna
September 27, 2011 at 11:30 pm
very good aricle to understand the basics idea how indian ruppes flutuate . and you made simle for common man like me . i can’t under stand economics subject or say not so keen because of its numerousand horible terms and defenintions i never liked reading it. but your practical explanations made it little bit understandable. thank you sir.
September 28, 2011 at 1:25 am
Hello James,
Thank you for the comments. Yes, the main intention of the article is to make awareness of the concept to the non finance backgroiund people. Good to hear that you are well understood the concept. If you have any suggestions for the new articles, please post it here.
Thanks,
Krishna
September 30, 2011 at 2:51 am
Hi Krishnas,
It is really a nice article.
I would like to know one more thing
How the increase of interest rate by RBI is going to solve the basic problem of inflation. RBI has revised the rate 13 times in 12 months with no effective result in reducing the inflation.
Please share ur views on it.
September 30, 2011 at 7:56 am
Hi Om,
Please read the below article:
http://www.thinkplaninvest.com/2011/07/why-interest-rates-on-loans-are-increased-by-the-banks/
Increasing the interest rates will not solve the problem. It is one of the factor to control inflation.
Thanks,
Krishna
October 11, 2011 at 1:49 pm
Very good one and simple to understand.
But I am little bit confused at the very basic point.
See the below statement from you post:
“It is clear that when more investors coming to India, the demand for the currency will be very high. Our rupee value will be increased against dollar.”
Here the rupee value will be increased aganist the dollar means, for 1 dollar the rupee value will be decrease that that of the existing value?(Ex: if current value of dollar is 45 rupees, rupee value increases means will 1 dollar becomes 44 rupees?)
October 11, 2011 at 4:49 pm
Hello Krishna,
Yes. If Rupee value increases means it is against that specific currency. Say today Rupee value increased or appreciated against the dollar, If yesterday it is 45, today it would have been 44 because Re1 got appreciated against dollar.
Note that currency fluctuation is always compared against the two currencies. Hope this clear your doubts.
Thanks,
Krishna
October 13, 2011 at 10:13 am
Nice Description..
October 15, 2011 at 4:32 am
It was a great artice and a great help. all d cumilated facts have been very effectively put across. i m looking forwad 2 a similar help on d topic of chinas policy on currency valuations
Thanks a lot
Jasmine
October 19, 2011 at 7:29 am
“rbi sold the dollar currency in the market to increase the value of rupee” wat does it mean?
October 21, 2011 at 12:02 am
Dear Krishnas
Thanks for the article. Also please comment on how other currencies will affect the change in INR-USD rates. For eg. in the current situation, INR seems to be depreciated with all other currencies. Does it has any direct relation ?
October 22, 2011 at 5:43 am
krishna thanks for the help..
could u please explain us also about gold standard and breetton wood bec i think its related to exchange rate..
thanking uu
October 22, 2011 at 7:30 am
Hello sir,
would u pls explain more on how fii affects on rupee? and i dont understand about the demand and supply concept in rupee. how it differs from the demand-supply concept of products.. would u pls help me…
Thanks..
Tushar
October 25, 2011 at 4:34 am
sir,
thnx a lot for this article,now i m capable to speak and discussion on this topic in my gd and pi,really its very easy to grasp the content,can u plz send me more link which is related to economy?
October 28, 2011 at 8:53 am
Thank u sir; your article is really informative.
Can you please explain about the relation of gold price and dollar?
November 5, 2011 at 12:12 am
AWESOME.this is the only word i am having for this article.i am a person relating to the technical field,and i don’t know even a,b,c of market,economics,but your comment help me to understand basic theory behind dollar-rupees valuation.
thank you.
November 16, 2011 at 1:33 am
hello deepak joshi,
Thank you for the comments.
-krishna
November 18, 2011 at 11:24 pm
Hi
Could u please let me know how much does the purchase of foodstuff from foreign brands like McDonald, or purchase of products like soaps etc would affect value of Indian products and value of rupee?
I had received a mail stating that purchase of Indian goods can increase the value of rupee. Hence I want to know how much would it affect?
Thank you.
November 21, 2011 at 3:01 am
Dear Sir,
As i am going to USA on 14th Dec 2011. I have not yet purchased USD thinking the USD rate will go after November 2011. Can you advise me should i buy USD now or wait till before 14th dec.
Sumit
November 21, 2011 at 3:03 am
Dear Sir,
As i am going to USA on 14th Dec 2011. I have not yet purchased USD thinking the USD rate will go down after November 2011. Can you advise me should i buy USD now or wait till before 14th dec.
Sumit
November 21, 2011 at 8:30 am
sir ,
your article is really informative.
can you please tell me about liquidity and hedge funds?
November 22, 2011 at 10:10 pm
hello sir,
is there anything in the hands of comman man for the rise of a rupee value.
What a comman man can do for the rise of the rupee value.
November 23, 2011 at 12:00 am
it is good but you not explan the restion bihand for tresary cantrol and way dollar use as a intranational carency
November 23, 2011 at 6:55 pm
Hi jaswant singh,
When you are using an international currency, the availability of that currency must meet the global trade. For dollar, USA’s GDP is very high and the demand for all the countries can be done.
Thanks,
Krishna
November 23, 2011 at 6:56 pm
Hello Rajesh,
There is nothing with the common man for this issue.
Thanks,
Krishna
November 23, 2011 at 7:05 pm
Hello sumit bhakta joshi,
There is very less chance for the USD rate to go down in the near term. More over, it would go down Rs. 50 for few months.
Thanks,
Krishna
November 23, 2011 at 7:07 pm
Hello Nikita,
Can you elaborate your question.
Thanks,
Krishna
November 23, 2011 at 11:18 pm
then who can help in the rise of the value of rupee and how could he
there must be some way for it
November 24, 2011 at 12:43 am
Hello Rajesh,
It depends on the global economy and our reserve bank’s policy. There are many criteria affecting the currency values. It is far apart from the common man.
Thanks,
Krishna
November 25, 2011 at 6:16 am
Wonderful article.It clear all the doubts of money value changes…
Thanks a lot for providing the information in a understandable way….
November 25, 2011 at 11:27 am
Good research.
November 25, 2011 at 10:27 pm
Hello Krishna,
The article is very informative.I have a question here what will the RBI to incrrease the rupee value besides controlling the interest rate
Will the gold price increase further?
Swapna
November 29, 2011 at 12:03 am
Hi Krishna,
I Just want to know that if the value of gold increases India’s Value increases, is this correct or not, if yes then how and if no then what is the fact.
One more major doubt i have in my mind that – how much money a country can print, i have already Google it but not satisfied, would be glad if i get an answer here.
Please reply accordingly.
Thanks !!!
November 30, 2011 at 4:01 am
Your articles are very useful and informative for amateurs. I really appreciate all your efforts.
1. I heard the amount of Gold reserve also determines the economic growth. is that true? although u mentioned once that foreign investors are switching towards Gold reserves.
2. RBI hiked the interest rates to control inflation… how does it works in reality? how exactly the cost of commodities will come down?
Thank you.
November 30, 2011 at 7:51 am
what makes dollar a global currency?
December 6, 2011 at 2:41 am
really super sir!thank you very much!!!!!!!!!
December 7, 2011 at 3:46 pm
hello sir
This is awesome article written by you in very simple language..thanks a lot…tttttttttttttt…….keep writing in simple language only so dat every one could understand..thanks again…