Friday, June 14, 2013

Rupee Fall Explained

This article was originally published in Postnoon on June 13, 2013
Prices are determined by demand and supply. And it is true for Exchange rates as well. Exchange rate is nothing but the price of a currency in terms of another currency. If the exchange rate between US dollars and Indian rupee is Rs58 per dollar, what it means is that you need Rs58 to buy one dollar. In other words, the price of a dollar is Rs58. So as the dollar becomes more expensive, or appreciates in value, one would need more and more rupees to buy one dollar. It means, the value of rupee is falling with respect to the dollar, that is, it is depreciating.

The exchange rate was Rs45.26 per dollar on June 12, 2011, compared with Rs56.75 per dollar on June 12th, 2013. The rupee has depreciated more than 25 percent in the last two years. It implies that the importers need to pay 25 percent more in rupee terms for the same quantity of goods, everything else remaining same; oil imports, gold imports, electronics, cars, foreign travels, education in US, everything for which one needs to pay in US dollars!
The depreciating rupee also implies improved revenues and good news for companies which charge for their products and services in US dollars, or for non residential Indians who send back money home.

But largely, people are worried. The stock market is worried and the worry is reflected in the falling indices. The central bank is worried as they fear that the falling rupee will result in an increase in inflation which has been tamed after maintaining high interest rates for a very long time. An increase in inflation would mean that any hopes of a reduction in interest rates by the Reserve Bank of India would be lost.

But why is the rupee falling? As mentioned earlier, it is all a play between demand and supply. The demand for rupee is falling, and the demand for dollar is increasing. Both resulting in a falling rupee. A few main reasons for the falling demand for rupee and the rising demand for dollars are:

·         Change in outlook for US by credit rating agency Standard and Poors from negative to stable and better than expected jobs data has increased the demand for dollar.

·         Decline in capital inflows and heavy outflow of funds due to foreign institutional investors pulling out their investments from the slowing Indian economy.

·         Falling gold prices lead to a surge in gold imports, resulting in an increase in demand for dollars.

·         Surge in oil imports, resulting in further widening of the current account deficit.
A strong exchange rate is what any country wishes for. For it is a reflection of the sound economy. The falling rupee does not boost the confidence of an already struggling Indian economy. Measures by the Reserve Bank of India and the Securities and Exchange Board of India to put a brake to the fall would be highly appreciated at this time.
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