What is the reason behind rupee value depreciation ?

September 25, 2011 Economy, Indian Economy 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. Rupee value depreciation is the hot topic nowadays due to the huge fall in value. 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 largely depends on the importing on Oil and other crucial raw materials needed 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 like us on facebook page.

also read:
Europe Debt Crisis What is Sovereign Debt problem? What is credit rating downgrade?

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 Rupee Value Depreciation?

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 rupee value depreciation. 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. However, if the countrys economy is not in good shape, no one can not stop the falling rupee value. 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. Updated (05-Sep-2013): Dr. Subbarao has retired from the RBI governor job and Raghuram Rajan took over as RBI governor from 5th September, 2013. He will assume the office for the next five years. He has the toughest challenge of fighting with the lowering economy and raising inflation.

Raguram Rajan Takes Over as RBI Governor

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. o o

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?).

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.

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 countrys 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. o

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.

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.

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 Hazares campaign of Fight for Second Freedom which took attention from global media. India needs political change to gain confidence among the investors.

Lighter Side

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, Indias 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 Indias 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.

Updated (09-July-2013): At present rupee against the dollar value is trading around Rs. 61. This is another historic low in Indian history. Fuel prices are shooting up to the peak. RBI has told that it will not much intervene on curbing the rupee decline. The only solution which good for the country is to strengthen the domestic market with industries that Agriculture, Hard Wares, etc. There is no rule that export should be only hard ware or

industry, even agri products should be produced more. Consider few years earlier, we could export lot food grains to other countries and also could maintain the inflation at lower level, how is that achieved?. So, there is a major flaw in the policies which could not trigger any employment and productivity. 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. Update (03-Sep-2013): The free fall of the currency continues without any look back. I have published another article on rupee value decline and its impacts. There is no sign of recovering in the near future. The major spoilers are Indias Oil imports and Gold imports. However, these are not the direct influencing factors, Indias economy itself shrinking to the lowest level not seen in the last four years. India has reported lowest GDP growth of 4.4% which lowest in the past four years. This resulted in the outflow of foreign investors caused huge damage to the rupee. Govt. and RBI is taking several measures to curb the rupee fall, but nothing will work out because the fundamentals of Indian economy is very weak and any steps taken by the govt. would be only for the short run. Food Security Bill is another biggest spoiler for Indias raising fiscal deficit. Also read : Indian students hit hard by falling rupee Why Indias Currency, The Rupee, Has Plummeted To A Record Low Against The Dollar More Slashed Growth Forecasts for India

Recommended Books on Currency and Economy

(These books are recommended based on this blog authors reading and good review taken from other websites. I would suggest these books if you want to get in depth knowledge on these subjects.) Currency Wars: The Making of the Next Global Crisis Subscribe to our future articles here. - See more at: http://www.thinkplaninvest.com/2011/09/what-is-the-reason-behind-rupee-valuedepreciation/#sthash.WJY4huIh.dpuf