What happens to make the rupee rise and fall
The valuation of the rupee in the country is handled by The Reserve Bank of India with its policy of managed float along with its external value. The Reserve Bank buys dollars from the market, adding to its foreign exchange reserves. This creates a sort of demand for the dollar (just like you would have demands for rice or apples) and raises its value. As in a shop where if the shopkeeper knows that something is in higher demand and its quantity is limited, its price goes up, the more you demand a dollar the price of the dollar goes up. This price is evaluated (or bought) with another currency and though I don't know the details, I'll simplify it and say it is evaluated with the rupee currency. So if I am buying in rupees and I want lots of "dollar goods" while only a certain amount is available, I have to pay more rupees for a dollar. Also, there are other processes going on, where relatives and friends of those in India send in dollars on their own. So now you have a situation where there are more of the "dollar goods" possibly leading to less demand. This can lower the value of the dollar. In fact, if the RBI did not buy dollars, these inflows would have sent the rupee spiraling in terms of dollars thanks to the forces of demand and supply. That means with more dollars available among people, since more people have their own share of the dollar good, the lesser the demand of the dollar with a certain amount available, the less valuable it becomes. An over-simplified version is, if suddenly no one wanted to buy dollars, you have lots of dollars available and the value of the "dollar good" is very low and the rupee is now stronger.
So What? - Trade
When we buy something from outside our country it is imported. These are bought with dollars but within the country, we use rupees for day to day financial transaction and salaries are commensurate with that. That means if a dollar is equal to a large number (large number > 40) of rupees, it costs more to buy an imported good in India. So as far as importing is concerned, it is favourable to have a smaller dollar to rupee ratio.
The opposite holds for exports, when we make something in India and sell it abroad, we make everything in rupees, but sell it in dollars, if we sell something with more dollars and a dollar is equal to a large number of rupees, n, we make n times the profit. So in the interest of exports, a larger dollar to rupee ratio is preferred.
RBI's Dollar-Rupee Policy
Recently, the RBI policy has shifted to allow the Rupee to rise against the dollar, consequently its on a 9 year high against the dollar. One important trigger for this is reversal is a rising inflation rate or a rise in the price of goods year after year. Inflation rate is controlled by a number of essential commodities like petroleum products and unfortunately, we do not produce them locally (yet!) A stronger rupee would make these goods cheaper (in rupees) in India. But, obviously, the rise in the rupee would make Indian goods costlier abroad and therefore cut into exports. In this way, exports are discouraged and more goods will be available for the local market, thus taming inflation. In a sense, a falling rupee would favour a "defensive" strategy of protecting home industries and hemming them in. Also, under the earlier policy of buying dollars with rupees, an equivalent amount of rupees was being put into circulation. Other things remaining the same, this would push up the inflation rate since you do not have that many goods that can be bought with this new found money. So what the government did was to create "artificial goods" in the form of government bonds, something which can lead to a vicious circle, that is beyond the scope of this article.
Miscellaneous Effects of Rising Rupee
- Inflation rate comes down
- Exports become less profitable, if the rupee keeps appreciating without contol, exports will suffer
- Since our currency is comparatively more free running than others, which are virtually pegged to the dollar, trade with those countries will be preferred since the prices of the goods produced by those countries will be unaffected.
- A slow growth rate in exports would lead to a slower GDP growth.
- If a company relies more on exports (such as Infosys and other premier software companies and pharma companies), its profits will be badly hit. If a company relies more on imports (such as the diamond industry), its profitability will increase. In our country the former kind of companies are in a clear majority with respect to wage earning and wealth generation. So it will be in general, a good idea to help them out. A similar position holds for the Indian steel industry which relies on exports heavily.
- It will be cheaper to travel abroad and purchase from online stores which deal in dollars. Conversely, it will be tougher for foreign tourists to come to India cost-wise and as a result, the Indian tourism industry could have a negative impact.
Posts
