What determines the rupee’s value?
- The value of any currency is determined by demand for the currency as well as its supply.
- When the supply of a currency increases, its value drops.
- On the other hand, when the demand for a currency increases, its value rises.
- In the wider economy, central banks determine the supply of currencies, while the demand for currencies depends on the amount of goods and services produced in the economy.
- In the forex market, the supply of rupees is determined by the demand for imports and various foreign assets.
- If there is high demand to import oil, it can lead to an increase in the supply of rupees in the forex market and cause the rupee’s value to drop.
- The demand for rupees in the forex market, depends on foreign demand for Indian exports and other domestic assets.
- For example, when there is great enthusiasm among foreign investors to invest in India, it can lead to an increase in the supply of dollars in the forex market which in turn causes the rupee’s value to rise against the dollar.
- This explains the current rise in value of the rupee.
Reason for the current rise in the value of Rupee
- Persistent foreign fund inflows into capital markets
- Softening crude oil prices
- Weak U.S. dollar in the global markets
- Slow pace of tightening by the U.S. Federal Reserve
Appreciation and Depreciation of Money
- Both the terms appreciation and depreciation are generally used in the exchange rate. In India, RBI plays a major role in depreciating or appreciating the Rupee value and maintaining the exchange rate. Most of the time RBI will not involve in exchange rate maintenance but sometimes RBI involves and manages the exchange rate of the rupee because when the Rupee value depreciates gradually rupee becomes weaker, and we have to pay more Indian rupees to purchase dollars.
- Appreciation of Money:
- Appreciation of currency means an increase in the value of the currency.
- The currency value is increased because when it is compared to the demand and supply of the other international currencies in the international market, by that the appreciation of the currency would be estimated.
- Depreciation:
- Depreciation means a decrease in the value of any financial asset.
- Depreciation of currency means a decrease in the value of the currency.
- It is also based on the demand and supply of the currency when compared to international currencies in the international market.
Impact of appreciation of Rupee
- Positive impact on Importers as the import becomes cheaper
- Negative impact on exports as the markets will be flooded by cheap exports.
- With the appreciation of the Rupee, exports become more expensive and less profitable for the domestic exporter since they end up earning less Rupees when exchanging the dollar. The actual cost may remain the same for the buyer, but Indian accounts would reflect a lower cash balance due to the currency difference.
- Sectors affected the most: IT
- When the Rupee is trending higher against the dollar, IT firms are severely hit since most of their revenue is accounted for by exports.
- It may have a domino effect on the overall stock market since the IT sector accounts for a significant chunk of the leading market indices.