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May 15, 2018

May 15, 2018 @ 10:42 AM

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Why Dollar Overpowers Rupee

Post MBA entrance exams when you will face GD & PI and during this period, your information on current affairs will prove to be very handy, not only content wise but you will remain a confident personality.

Following article on “Why Dollar Overpowers Rupee?” should give insight  to you.

Indian National Rupee and US Dollar are the legal tenders in India and the US respectively. Both USD and INR are accepted in the US and India respectively because they meet following conditions which are necessary for anything to be called as money –

1.    General Acceptability
2.    Unit of account
3.    Store of storage
4.    Medium of Exchange

For general acceptability means that no one should refuse from accepting it; unit of account means that is can be used to represent the real value of an economic item; for store of value, it means that if it is stored, it value must not perish; and for medium of exchange, it means that it can be used as a medium for exchange of goods and services. 

As the aforesaid conditions are satisfied for Rupee in India and Dollar in the US, both the currencies are used as money in respective countries. However, in international trade when the nations carryout exchange of goods and services among themselves, Rupee lacks the general acceptability while Dollar, Gold, Special Drawing Rights (SRD) of International Monetary Fund (IMF)  and some other hard currencies like Euro, Japanese Yen, etc. are accepted by almost all countries as a medium of exchange. Thus dollar becomes the international currency while Rupee remains a currency in India only. 

Rupee Vs Dollar

As it is already explained why Rupee is a national currency while Dollar is an international currency, now let’s take a look on the factors which make Dollar stronger than the Rupee. 

1.    Current Account Deficit

The value of any currency in terms of international currency is determined by the demand and supply of the international currency in a particular country and the demand and supply depends on the nature of Balance of Payments (BOP) of a country. BOP is the foreign trade account divided into two parts – Current Account and Capital Account. All the trade in goods and services and foreign remittances are entered in current account while financial exchanges like loans, or overseas investments, Foreign Direct Investment (FDI) or Foreign Institutional Investment (FII) etc. are the part of capital account. If the value of exports is higher than the value of imports, then their will be a current account surplus and there will be a current account deficit if vice versa. 

The export from a country determines the supply of dollar as they will receive dollar from international market for their sold goods and services. Similarly, the imports determine demand of dollar. If imports from a country are higher than the exports from that country, then the demand of dollar will be higher than supply and the domestic currency like Rupee in India, will depreciate against the dollar. Similarly, if exports outpace the imports, then supply of dollar will exceed demand and Rupee will appreciate against dollar in India. In other words, if a country is having current account deficit, the local currency will depreciate against dollar while if it is having a current account surplus, the local currency will appreciate. 

In case of India, if BOP account will continue to have a current account deficit, Dollar will continue to overpower the Rupee. 

2.    Movement Of Capital

Not only just current account but capital account of BOP also determines the value of dollar against a currency. The capital account details the flow of foreign capital in and out of the country. If there is net foreign capital inflow in India in the form of FDI or FII, then the supply of dollar will be much higher than demand and Rupee will strengthen against the dollar. Similarly if there is net capital outflow, Rupee will depreciate. 

3.    Other Factors

There are several other factors also which determine the supply of dollar into the country. The foreign capital usually flows into the region which provides minimum risk and maximum returns. Higher interest rates in a country suggests higher returns. Therefore whenever Fed Reserve of the US increase the interest rates, there is turmoil in all financial markets across the globe because there is a risk of flight of Dollar back to the US. Since US is the largest economy of the world, it is also minimises the risk. As the risk factor also determines capital movement, most countries give significance to the risk rating by international agencies like Moody’s, Fitch etc. It is because of the risk factor that despite high interest rates in Zimbabwe, most investors ignore it. 

And last but not the least, Dollar is an international reserve currency and it is because of this reason, it overpowers most currencies across the world. The strength of US economy vis a vis Indian economy is another reason why Dollar overpowers the Rupee.

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