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April 04, 2017 @ 01:15 PM

April 04, 2017 @ 01:15 PM

Depreciation Phenomenon of Rupee vs. Dollar

Depreciation Phenomenon of Rupee vs. Dollar

Published : Tuesday, 17 January, 2017 10:30 AM

Depreciation Phenomenon of Rupee vs. Dollar

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Read Current Affairs Topic:  Depreciation Phenomenon of Rupee vs. Dollar

When the value of Indian Rupee (INR) against another currency says US Dollar (USD) decreases in the foreign exchange (forex) market, it is called as depreciation of Rupee and on the contrary if the value of INR increases against USD, it is called as appreciation of Rupee. In the post-independence history, the government of India has also deliberately decreased the value of Rupee three times once in 1966 and twice in 1991. When the government officially decreases the value of its currency, it is called as devaluation of currency.

Working Of Depreciation or Appreciation Of Rupee

In the forex market, when the demand of foreign exchange say USD exceeds the supply, it will result in the increase in the price of USD in terms of rupee. In other words, value of rupee will decrease against USD and it is called as depreciation of Rupee.

For example, in a forex market, if USD 1 can be purchased with INR 67 but after some time later its price in increased to INR 68, then Rupee is said to be depreciated by one Rupee. Again, after some time if USD price decreases to INR 67, then Rupee is appreciated by one Rupee.

Factors Affecting Depreciation

Factors responsible behind the depreciation of Rupee are actually the factors which affect the supply and demand for dollar in the forex market. Some of the major factors affecting the price of USD in the forex market or in other words factors which affect the value of Rupee in forex market are as under:

Balance of Payment Surplus or Deficit

The account of international trade of a country is called as balance of payment (BOP) account. In a BOP account, if the aggregate of credit column is larger than aggregate of debit column, it means that supply of foreign exchange is higher than the demand for foreign exchange, In that case, the domestic currency will appreciate against the foreign currency. On the contrary, if there is BOP deficit, i.e. cumulative entries in debit section are bigger than that of credit section, it means that there is net outgo of forex and value of domestic currency will depreciate. In gist, demand for USD is more than the supply of USD.

Exports vs Imports

This is also related to the BOP account. The goods and services exported by a country brings the foreign currency into the country while the goods and services imported into the country requires the payment to the foreign suppliers in an internationally accepted currency like USD. If a country’s imports are more than the exports, then Rupee will depreciate as the USD required to pay the foreign suppliers will exceed the USD brought into the country by exports.

Inflation

If a country is undergoing high rate of inflation, then the currency of the said country is expected to depreciate in the forex market. Inflation means a consistent increase in the general price level or decrease in the value of currency. An increase in the price of goods and services in domestic market will make them less competitive in the international market and thus the exports will reduce. Also, during the high inflation period, imports will increase as it will be cheaper to import corns than to produce them domestically because of high price. Thus, inflation will increase imports and decrease exports thus strengthening the depreciation of the currency.

Rate Of Interest

High interest rate is not considered good for the economy while low interest regime is considered business friendly. However, there are many foreign institutional investors (FIIs) in the world who park their funds where they get better interest rate. If the Reserve Bank of India (RBI) lowers the rate of interest to improve business environment, then such FIIs will pull out their money from the Indian market and invest in some other country where interest rates would be higher. Thus there would be an outflow of the foreign currency and would cause depreciation.

Speculation

There are many speculators in around the globe who invest in different international currencies in anticipation of rise or fall in their prices in future. There are many factors which may affect the speculators anticipation like expected economic growth, inflation, business policies etc. If a country's currency value is expected to rise, investors will demand more of that currency in order to make a profit in the near future resulting in the increase in the value of currency.

Conclusion

Almost all the aforesaid factors and several other minor factors simultaneously act to depreciate or appreciate the value of a currency. However, their affect is more visible if a country is under flexible exchange rate regime like India. In the fixed exchange rate regime as in China or in pre-reform India, exchange rate is artificially fixed by the government and these factors don’t affect the exchange rate but put the strain on government finances.

Fixed exchange rate regimes do not have appreciation of depreciation of currency but government changes the value of currency by devaluation or evaluation. In fixed exchange rate regime, government had to maintain forex reserves to maintain the fixed rate of a currency. However, nowadays, governments with flexible exchange rate also keep forex reserves to provide cushion against exchange rate shocks.  

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