Why Rupee is Depreciating??????

Now a days I am getting so many questions related to rupee/dollar value. When the rupee moves from 53 per US dollar to 56 per US dollar, why do we call it ‘rupee depreciation’ and not ‘rupee appreciation’ given that the rupee has risen against the dollar? Why it is happening and what are the factors which majorly control it?

This is a question for lot of people. Let us look at that with a simple example.

Let’s replace rupee with eggs. Today, one USD can buy 45 eggs. Tomorrow, 1 USD can buy 52 eggs. Doesn’t this means that eggs have become cheaper since you can buy more eggs for the same one USD? Alternatively, it means that eggs have depreciated in value.

The same is true for the rupee. When one USD can buy 45 rupees today and 52 rupees tomorrow, it means that the value of the rupee has depreciated.

The past two weeks have been disastrous for the rupee value against the dollar. The value of rupee against dollar has moved from 53.63 during the second week of May, 2012, to almost 56.5 during the yesterday.  The weakening of rupee may continue for some more time, as per the experts. This kind of increase in dollar value will have the drastic impact on the economy of the country like India, which depends too much on oil and other raw material imports.

How currency value is decided?

There are many economic factors, which decide the value of a currency. A currency will tend to become more valuable when its demand is higher than supply. It is the basic theory.

Exchange rates are expressed as a comparison of two currencies and it is always relative. Interest rates, rate of inflation and exchange rates are correlated.

What are the main reasons for depreciation of Indian rupee now?

Stock market performance

It is a known fact that Indian stock market is dominated by overseas investors. When the economy is performing well and stock market is performing better than other countries, overseas investors will become heavy investors here. To invest here, they require rupee. This will increase the demand for rupee and will result in higher value for rupee. On the other hand, when these investors are pulling money out of Indian stock market, rupee will be depreciated. Indian markets are in a bad shape for the last 1 year. The sentiments after the US downgrade and the European crisis etc. resulted in overseas investors selling in India and buying dollars.

In a bad performing market, when there is depreciation in rupee, it will bring down the overseas investors real returns. So they will start selling, which will again deepen the situation.Despite all the problems in the US, the dollar is still the safest paper currency in the world! So, there is more demand for dollar in volatile condition like this. This will add to the rupee depreciation.

Very high prices for gold have created panic among investors and fearing a bubble there, investors started moving towards dollar. This demand in dollar is also causing depreciation of rupee.

Inflation

Another factor affecting the currency value is inflation. We are experiencing very high inflation rate in India now. This will decrease the purchasing power against other currencies. This will leads to depreciation of the currency.

Current account deficit

Current account deficit occurs when a country’s total import exceeds the total exports. This makes the country, a net debtor to the rest of the world. A high deficit indicates, we are doing more trading outside the country than it’s actual earning inside the country. This is not good for the country because, the country needs to buy more foreign currency. More demand for the foreign currency will reduce the value of that country’s currency.

India’s current account deficit is more than the expected level now and this also contributes to the depreciation of Indian rupee.

Why and how RBI control exchange rate?

RBI will interfere in this area because a steady value of rupee is essential for the orderly growth of the economy. A depreciating rupee will harm oil marketing companies, and other import oriented businesses. This may help the software companies and other exporters, who get their payment in dollars.

RBI will be watching the position and interfere to stabilize the currency value. In case of depreciation, RBI will sell foreign currency from the reserve and this will help in arresting the fall of rupee to some extent.

The RBI is likely to have sold dollars in spot markets via public sector banks to prevent the rupee from falling beyond the psychologically key level of 56 per dollar, according to reports. The RBI is also said to have intervened in the forward markets. Some banks were seen selling off their long dollar positions ahead of the weekend. Some selling from exporters who had missed Thursday's deadline to convert half of their foreign currency holdings into rupees was also cited by traders, according to reports. Besides selling of dollars by some public sector banks and exporters, a rebound in the local stocks and steps taken by the RBI helped the rupee recover from an all-time low on Thursday. The RBI will take the required steps, consistent with its policy, to curb swings in the rupee

Source-Stateofthemarket.finvin.in