To better understand the fluctuating dollar value against the rupee, let us get to know some basics:
Exchange rate – the rate at which a currency can be exchanged. It is the rate at which one currency is sold to buy another.
Foreign exchange market – Also known as “Forex” or “FX”. It is a market to trade currencies
Indian foreign exchange rate system – India FX rate system was on the fixed rate model till the 90s, when it was switched to floating rate model. Fixed FX rate is the rate fixed by the central bank against major world currencies like US dollar, Euro, GBP, etc. Like 1USD = Rs. 40. Floating FX rate is the rate determined by market forces based on demand and supply of a currency. If supply exceeds demand of a currency its value decreases, as is happening in the case of the US dollar against the rupee, since there is huge inflow of foreign capital into India in US dollar
Why is the US dollar walking down? – When it comes to the US being a consumer, it has one of the largest appetites in the world. To keep up its demand for consumption, its imports are huge when compared to exports. This created pressure since there were more payments in dollars than receipt of any other currency, which made the supply of the dollar greater for imports payment and less receipt of foreign currency from exports. This resulted in the depreciation of the dollar’s value, which again caused more outflow of dollar for import payments. This created a state of inflation and made consumables costlier to US. To control inflation US resorted to increase in interest rates to cool down pressure on demand side of consumption. This factor along with recession in all other sectors, particularly real estate, is causing the mighty US dollar to shake.
Impact of dollar fluctuations on the Indian economy
Until the 70s and 80s India aimed at to be self-reliant by concentrating more on imports and allowing very little exports to cover import costs. However, this could not last long because the oil price rise in the 1970s and 80s created a big gap in India’s balance of payment. Balance of payment (BOP) of any country is the balance resulting from the flow of payments/receipts between an individual country and all other countries as a result of import/exports happening between an individual country, in our case India and rest of the world. This gap widened during Iraq’s attempt to take over Kuwait. Thereafter, exports also contributed to FX reserve along with Foreign Direct Investment into the Indian economy and reduced the BOP gap
Indian rupee appreciation against dollar impacted heavily to the following:
Exports from India are of handicrafts, gems, jewelry, textiles, ready-made garments, industrial machinery, leather products, chemicals and related products. Since the 1990s, India is the world’s largest processor of diamonds. The mentioned export items contribute substantially to foreign receipts. During the periods when the dollar was moving high against the rupee, exporters stood to gain, when $1 = Rs. 48, was getting them Rs. 4800 for every $100. Since the beginning of the year 2007, rupee appreciated by about 10%. With its value of rupee Rs. 39.35 = $1 as on 16 Nov 2007, for every $100, exporters would get only Rs. 3935. This difference is towing away the profit margins of exporters and BPO service providers alike.
Imports to India are of petroleum products, capital goods, chemicals, dyes, plastics, pharmaceuticals, iron and steel, uncut precious stones, fertilizers, pulp paper etc. With the same scenario as given for export, if we analyze - an importer is paying Rs. 3935 now instead of Rs. 4800 paid during yester years for every $100. This gain on FX is likely to create savings in cost, which could be passed on to consumers, thereby contributing to control inflation
Foreign investment into India is also contributing well to dollar depreciation against dollar. With the recent liberalized norms on foreign investment policy like – Foreign investment of up to 51% equity limit in high priority industries; foreigners & NRIs are allowed to repatriate their profits and capital with exception for Indian nationals who were allowed to do so only under special circumstances; allowing free usage of export earnings to exporters, made foreign investment in India very attractive. It is this favorable atmosphere which made FX reserve surplus in US dollar and helped rupee to appreciate
Conclusively, appreciation and depreciation of rupee cannot certainly be taken as beneficial to the Indian economy in general. On one hand the rupee appreciation will affect exporters, BPOs, etc., on the other, rupee depreciation will affect importers. So now it depends on what the future has to reveal for, how effectively the central bank can balance the FX rates with little impact to the relative areas of FX usage. Can the Dollar remain king or not, is no longer a million dollar question, but a million Rupee question!
Chillibreeze's disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect the views of Chillibreeze as a company. Chillibreeze has a strict anti-plagiarism policy. Please contact us to report any copyright issues related to this article.
Out of 5 “chilies”, our editorial team gave this article...
—About our writer:
Aneez writes for Chillibreeze.
>> Read more articles written by Chillibreeze writers: