What is the reason behind rupee value

depreciation?
Introduction
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 "".# $ "#.0 range! at this time of writing
this article it is hovered to the range of "%.0 $ #0.0. &t is e'pected 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
&ndia heavily depends on the importing on (il and other crucial raw materials needs for the industries.
This article e'plores the reason behind the rupee value depreciation! how RBI trying to defend the
rupee value and how it is going to affect the industries. & come up with this article after the readers
re)uest to understand the currency war on recent days.
How currency value is determined?
*e 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. +ere & 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. &t is the basic theory.
*e 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. &nterest rates! &nflation and
e'change rates are highly related. ,eserve bank change the interest rates to control the &nflation and
e'change rates.
*e can take our real time e'ample of stock market investment to understand the above principle. As
we know that! our stock market is dominated by the overseas investors (outside &ndia! because of
the our growing economy and industrial development. *hen our economy is doing well and market is
performing better than other countries! overseas investors would invest heavily on our market. +ow
they would put it in our market-. They will sell or convert to our currency and invest in &ndia. &t is
clear that when more investors coming to &ndia! the demand for the currency will be very high. (ur
rupee value will be increased against dollar. &n the same way! when they are pulling out of market!
demand for the rupee will be decreased and value is depreciated.
+ere & 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 e'ample is given to e'plain it in
simple words! the demand for a currency would come in the different way. *hen 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.
&f a currency is free-floating! its e'change rate is allowed to vary against that of other currencies and
is determined by the market forces of supply and demand. .'change rates for such currencies are
likely to change almost constantly on financial markets! mainly by banks! around the world. A movable
or ad/ustable peg system is a system of fi'ed e'change rates! but with a provision for the devaluation
of a currency. 0or e'ample! between 1%%" and 200#! the 1hinese yuan renminbi (123! 4 was pegged
to the 5nited 6tates dollar at 47.2897 to :1.
Why RBI intervene on Currency valuation?
&n the last week we have seen RBI has acted to stop the erosion of rupee value against the dollar
currency. *hat it did was sold the dollar currency in the market to increase the value of rupee. ;ut! it
is very difficult for the ,eserve ;ank of a country to ad/ust the value of the currency! the long term
solution would be fi' the problem in economy and bring the inflation into control. 3ou would wonder
why RBI has to intervene on currency value decrease or increase. 2ote that! RBI would not allow
currency to be higher after certain level because of the e'ports would get affected like &T companies
would suffer if the rupee get appreciated against the dollar.
&ndia is heavily depend on the import of raw materials and (il for its industrial development. &n the
decreasing rupee scenario! the outgo of money will be much higher. his would affect the expenses
for the companies who imports raw materials for their factory and all the !il "ar#eting
Companies $!"C% will incur heavy payment to import the !il. 2ow you would have understood
why the <etrol prices have been increase in the last fortnight. &f you look into the news papers! the
reason said by our finance minister was the depreciation of rupee value against dollar.
"a&or 'actors Influencing the Currency (alue
&n the above section! & have e'plained 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 ma/or 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.
Inflation
o As a general rule! a country with a consistently lower inflation rate e'hibits a rising
currency value! as its purchasing power increases relative to other currencies (What
is Inflation?.
Interest Rates
o A higher interest rates offer good returns compare to other countries. &t will result in
the foreign capital come into the country. =ower interest rates decrease the currency
value. 2ote 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.
Current )ccount *eficits
o ;asically current account of a country presents the status on the trade of a country
between other trading partners. &f 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. >ore demand for
the foreign currency would reduce the value of that country?s currency.
Impact of I+R vs ,-*
&n the last two weeks &ndian rupee has depreciated about 8@ against the 56A dollar value. &t is
e'pected that it would continue the slide as many macro economic factors not in favor of &ndian
economy. The following are the factors which would slide down the rupee value.
'oreign 'unds !utflow
o &t is the ma/or concern of &ndian economy now. ;ecause of the global uncertainty and
various economy crisis like .urope sovereign debt problem! 56 economy problem! etc
leads to search for the safe heaven among the investors. They are )uickly pulling out
the money fro &ndian market and investing in any other safe investments like Aold or
56 dollar.
.overnment *eficit is High
o The government finances are in a bad shape and the combined central and state
government deficit has stubbornly stayed around 10 per cent of AB<. &t is high deficit
and investors lost faith in the local economy.
/olitical ,ncertainty and Corruption
o This is one of the ma/or factor for any country to stabiliCe the economy. &n &ndia! last
one year we are seeing the series of corruptions and there is no good news from the
ruling party (1ongress about the economic reforms and lot of agitation among the
citiCens including the veteran Aandhian Anna +aCare?s campaign of 0ight for 6econd
0reedom which took attention from global media. &ndia needs political change to gain
confidence among the investors.
-ummary
& hope this article would have given an idea about the rupee depreciation and the reason why the
currency is changed. ;ut! there are hundreds of parameters to decide a currency value and politics
also there to manipulate the own currency which 1hina has done for a long time. The above are the
very basic idea on currency value and how it is affected. &f you have any thoughts! please post ti in
the comments section
Inflation 0 Introduction
&n this article & will be writing about the Inflation and how it will affect the prices. >any people have
the wrong conception about the inflation and prices relationship. This article will point out what is
inflation and what is the relationship with price changes. &t is one of the important concept everyone
must know in the daily life. After reading this article post your feedback on the comments section. &
would like to response to all your feedback. 3ou can subscribe to our future articles here.
What is Inflation?
&nflation is term used for describing the percentage of increase in the price levels. &t can be calculated
in weekly! monthly or annually. 2ormally it is represented in the annualiCed figure. Inflation is
calculated based on the Wholesale /rice Index$W/I% in &ndia. >any countries finding the inflation
using the Consumer /rice Index$C/I%.
As their names suggest! the C/I pertains to a set of items that a consumer consumes while the W/I
is a basket particular to the wholesale market. Therefore! if the inflation for a particular week is! say!
10 per cent! it means the inde' is 10 per cent higher than it was the same week the previous year.
Then there is core-inflation! which means the inflation rate without taking into account food and
fuel. 6ome say both need to be taken out because of their volatility! while some argue that both items
cannot be taken out because a consumer does pay for the rise in their prices.
How to calculate Inflation Rate?
The following is the formula used for calculating the inflation rateD
&nflation ,ate E (<o- <-1F 100 G <-1!
where
<o E the present average price
<-1 E the price that e'isted last year.
&nflation rate is always presented in the percentage.
)ppreciation and depreciation of currency
As per my post on basics of appreciation and depreciation of rupee, we saw what appreciation and
depreciation of rupee means. Now this post will help us to understand what causes appreciation and
depreciation of a currency and its effects.
As from our previous example, we assume that there are 2 countries India and USA, and there is flexible
exchange rate regime. herefore value of currency of each country in terms of the other depends on the
demand and supply of their currencies. It is in the foreign exchange mar!et that exchange rate among
different countries is determined. It is a mar!et in which currencies of various countries are converted into
each other or exchanged for each other. In our case, Indians sell rupees to buy US dollar and the
Americans will sell dollars in exchange for rupees.
Demand for dollar
Now demand for dollar by Indians arises due to the following"
# he Indian individuals, firms or government who import goods from USA into India, as they need to pay
for goods and services imported.
# he Indian individuals travelling and studying in USA would re$uire to meet their travel expenses and
education expenses.
# he Indians who want to invest in e$uity shares and bonds of the US companies and other financial
instruments.
# he Indian firms who want to invest directly in building factories, sales facilities, shops in USA.
Supply of dollar
%et&s see what causes supply of dollars in exchange mar!et"
# he individual firms and government which export Indian goods to USA will earn dollar from American
residents who would buy Indian goods imported into USA and pay their price in dollar.
# Americans who travel to India and use the services of Indian transport, hotels etc .will also supply dollars
to be converted into rupees for meeting these expenses.
# American firms and individuals who want to buy assets in India , such as bonds and e$uity shares of
Indian companies or wish to ma!e loans to Indian individual and firms will also supply dollars.
'$uilibrium is establish in foreign exchange mar!ets by simple demand and supply of currencies(..when
)emand* supply, then foreign exchange mar!et is said to be in e$uilibrium. he e$uilibrium in the foreign
exchange mar!et will be disturbed if some changes occur in the underlying factors that determine the
demand for and supply of foreign exchange.
Appreciation of rupee
+or e.g., if there is in increase in incomes of American people due to boom conditions in the US economy,
it will affect the e$uilibrium rate of exchange. he increase in incomes of the people of USA will lead to
increase in demand for imported goods those of India. Now this would lead to increase in supply of
dollars, which would in turn lower the price of dollars in the foreign exchange mar!et by simple theory of
demand and supply, as now there will be excess supply of dollars. his implies that increase in imports by
USA from India leading to more exports from India will cause dollar to depreciate and Indian rupee to
appreciate.
Depreciation of rupee
,n the other hand if due to increase in incomes of Indian people causing arise in demand for American
consumer goods or there is pic!ing up of industrial activity in India re$uiring more imports of material,
machines e$uipments and other capital goods from USA the Indian imports from USA will increase. he
increase in imports from USA by India will have to be paid in dollars causing demand for dollars to
increase. his will cause dise$uilibrium in the foreign exchange mar!et, as with increase in demand for
dollars, there will emerge excess demand for dollar which will push up the price of dollar and this rise in
price of dollars in terms of rupees implies depreciation of value of rupee.
How does China Manipulate its Currency?
by Manshu on January 26, 2009
in Articles
Chinas currency manipulation remarks by Mr. Tim Geithner hit the ront pa!es o all
ma"or ne#spapers last #eek. $o lets take a look at ho# China manipulates it currency.
To be air to China, almost e%ery country in the #orl& manipulates its currency. 'n an i&eal ree
market #orl& ( there #oul& be no !o%ernment inter%ention in the currency markets. )o#e%er,
there is har&ly any Central *ank in the #orl& that &oesnt inter%ene, #hen its currency starts to
appreciate or &epreciate beyon& a certain price ban&.
Almost e%ery Central *ank has a certain price ban& or its currency in its min&, an& as soon as
the currency !oes beyon& that ban&, !o%ernments start inter%enin! in one #ay or the other.
This !o%ernment inter%ention can be &irect or in&irect.
Buying Dollars to Keep the Dollar Price High
China has been intereste& in keepin! the +uan ,Chinese Currency- un&er%alue& relati%e to the
.$ /ollar, an& the easiest #ay ,i you can aor& it- to keep the /ollar price hi!h, an& the +uan
lo# is to buy &ollars rom the open market.
A country like China, #hich runs a hu!e Tra&e $urplus can aor& to buy &ollars in the open
market to keep the &eman& or &ollars hi!h, an& push the &ollar price up#ar&s relati%e to the
+uan. This keeps the +uan un&er%alue&.
Indirect Measures
There can be in&irect inter%entions like puttin! a cap on the amount o orei!n assets that locals
can in%est abroa&. 0or e1ample ( 'n&ia allo#s its resi&ents to in%est only up to 230,000 in
orei!n assets e%ery year.
4ther in&irect measures can relate to ta1ation la#s. 0or e1ample ( by allo#in! ta1 ree
repatriation o the Great *ritain 5oun& ( the *ritish !o%ernment can help boost inlo# o 5oun&s
in the country, an& inluence the e1chan!e rate.
Why Does China Wish to Undervalue the Yuan?
Chinas en!ine o !ro#th is e1ports. The lo#er the %alue o the +uan, the better it is or Chinas
e1porters. *asically, i 6 /ollar buys 7 +uans, an& a e1porter sells a Chinese $hirt or 60 &ollars
( he pockets ! yuans. *ut i one /ollar #as #orth only 3 +uans, the e1porter #oul& only be
able to pocket "! yuans#
By How Much is the Yuan Undervalued?
't is really impossible to tell by ho# much the +uan has been un&er%alue&, but estimates su!!est
that this ran!e is bet#een 638 ( 908.
A &irect conse:uence o keepin! the local currency un&er%alue& is inlation, an& since China
ace& rather hi!h inlation rates in 200; ( it &i& plan to let its currency appreciate in 200; ,but
that #as beore sub<prime-.
How is the U$ I%pacted?
't can be ar!ue& that the .$ is loo&e& #ith cheap imports rom China not because China is
really cost ( competiti%e, but because China has artiicially kept its currency un&er%alue&. ' the
+uan #as allo#e& to appreciate ( Chinese imports may no lon!er be cheap enou!h to compete
#ith American pro&uce& !oo&s.
4n the other han&, it coul& really be that the Chinese are cost competiti%e, an& it is really cheaper
to pro&uce !oo&s in China than it is to pro&uce them in .$.
The truth probably lies some#here in the mi&&le.
U$ $ti%ulus $pending
The .$ runs hu!e tra&e &eicits, an& has plans or massi%e stimulus spen&in!. The &eicits mean
that this stimulus spen&in! can be &one by either issuin! more &ebt to orei!n countries or
printin! more &ollars.
' Mr. Geithners comments continue= they may a!!ra%ate China to such an e1tent that it stops
sho#in! up at the Treasury *on& auctions.
' that happens, then the .$ #ill ha%e to resort to printin! currency an& :uantitati%e easin! on a
scale that unleashes massi%e inlation.
't #ill be interestin! to see ho# the situation unol&s, an& ho# Mr. Geithner &eals #ith Chinas
>Manipulation? ( if an& when he actually takes oice.