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What is an exchange rate. Are terms like managed float, dirty float, fixed exchange rates,
floating exchange rate, pegged exchange rate, crawling peg the same? Which type of
exchange rate regime does India follow? What is a currency crisis? In recent times the
rupee is becoming weaker against the dollar every day, what are the reasons for the
same and what steps is the RBI taking to control the same. So, is the rupee depreciating
or devaluing against the dollar? Support your conclusion by giving a dollar rupee
graphical trend for the last three months?
Example
The amount at which exchange rate will be higher for one euro in terms of
one yen, the lower the relative value of the yen.
Managed float
The managed float is a type of float in which a process of floating of a currency takes
place where the exchange rate is controlled by the central bank managed float is
also called dirty float
Dirty Float
Managed float and dirty float are same thing which can be understood by the example
below
For example, country X may find that some hedge fund is speculating that its
currency will depreciate substantially, thus the hedge fund is starting to short massive
amounts of country X's currency. Because country X uses a dirty float system,
the government decides to take swift action and buy back a large amount of its
currency in order to limit the amount of devaluation caused by the hedge fund.
A dirty float system isn't considered to be a true floating exchange rate because,
theoretically, true floating rate systems don't allow for intervention.
rate system is to maintain a currency of country value into a very narrow band. The
fixed exchange rate system may also be referred as the rates which are fixed may provide
greater certainty to exporters and importers. This also helps the government to
maintain inflation at low rate, which in the long run should keep interest rates down and
stimulate increased trade and investment
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OIL PRICES
India imports 83 per cent of its oil requirements (last year's bill was $150 billion). The
monthly demand (of $12 billion) on this account as well as rising oil prices has usually
kept the rupee under pressure. Apart from oil, there are gold imports for which the
country paid nearly $60 billion last year.
Now, ironically, prices of both oil and gold have been coming down - which is expected
to have favourable impact on the trade deficit this year. Brent crude prices have dropped
to $90 a barrel, a drop of nearly 30 per cent since early 2012. A $1 decline in oil prices
should help reduce current account deficit by about $1 billion. The drop in oil prices has
allowed markets to project that trade deficit will be down by $25 billion this year. Such
inferences should in the normal course have led to an appreciation of the rupee. This is
something market experts say will still happen - eventually - perhaps in six months to
one year. But in the short term there is a mood of panic and poor sentiment and dire
predictions that the rupee is heading for 'retirement' - the euphemism for its value
touching 60 to the dollar. There is now a unidirectional and sustained downtrend in the
short-term, market experts say.
For example experts say that importers are increasing the tenor of their cover - the
protection they buy against a further decline in the rupee. In simple terms, if importers
covered their import bills for 2 months earlier, they are now doing it for three to four
months. This, they say is contributing to panic, further volatility and uncertainty. In
contrast, exporters, revenue earners such as software industries, are not selling dollars
that they earn, waiting for the rupee to depreciate further.
BUNCHING PAYMENTS
Experts say that bunching of payments by oil companies (for oil imports) in the spot
market has increased demand for dollars in the short term. Normally, oil companies
avail of short-term buyer credit of between 3-6 months and stagger their payments.
However, with the rupee depreciating so drastically, they prefer to pay their bills
immediately rather than buying on credit. This creates a further pressure in an already
frayed market.
STEPS BY RBI
Normally, the Reserve Bank is trying to cool this down by opening a special window for
oil companies (so that they don't buy more dollars in the market) for a short period of
time. There has been such talk in the market although there is no official word yet. RBI
recently indicated that it will sell dollars directly to oil companies in order to ease
pressure from the currency. Besides, the central bank has already taken steps to curb
speculation in the forex market and tried to increase the inflow of foreign currency.
Since early March, rupee has lost about 13 per cent against the dollar driven by a
combination of deteriorating global risk sentiment and weak domestic fundamentals.
The rupee gained 27 paise to close at 55.37 after RBI intervened on currency breaching
the 56-level in early trade.