News Highlights
The Indian Rupee Exchange Rate fell to a new low against the US dollar, as domestic stock markets fell and foreign investors continued to sell Indian equities.
The Indian rupee breached for the first time Rs 79 per dollar level in post-market trade.
Focus Points
- The rupee has lost more than 6% against the dollar so far this year, and analysts believe it is likely to weaken further.
- The Indian Rupee has been adversely affected mainly by the FIIs pulling out funds from the equity market, rising crude prices, the deteriorating trade balance and dollar strengthening
What is the Exchange Rate?
- Exchange rate is the price of one currency in terms of another currency.
- Exchange rates can be either fixed or floating.
- Fixed exchange rates are decided by central banks of a country whereas floating exchange rates are decided by the mechanism of market demand and supply.
Exchange Rate of Indian Rupee
- The exchange rate of the rupee against the US dollar tells us how many rupees are needed to purchase one US dollar.
- For importing products from US, Indians must first purchase dollars and then use those dollars to purchase the product and vice versa
How is the value of a currency determined?
- The value of a currency is determined by the basic economic concept of Demand and Supply.
- If Indians demand more dollars in comparison to Americans demanding the rupee, the exchange rate will FALL for rupee and STRENGTHEN for dollar.
- However, in India, the market does not fully determine the exchange rate.
- The Reserve Bank of India (RBI) occasionally intervenes in the foreign exchange (forex) market to ensure that the rupee’s price does not fluctuate too much or rises or falls too dramatically all at once.
Factors Affecting Exchange Rate
- Intervention of The Reserve Bank of India:
- During high volatility in the exchange rate, RBI intervenes to prevent the exchange rate going out of control.
- For example, the RBI sells dollars when the Indian rupee depreciates too much, while it purchases dollars when the Indian rupee appreciates beyond a certain level.
- Inflation rate:
- The increase in inflation rate can increase the demand for foreign currency which can negatively impact the exchange rate of the national currency.
- For example, an increase in the inflation level of petroleum oil can increase the demand for foreign currency leading to the depreciation of the Indian rupee.
- Interest rate:
- Interest rates on government securities and bonds, corporate securities etc affect the outflow and inflow of foreign currency.
- If the interest rates on government bonds are higher compared to other country forex markets, it can increase the inflow of foreign currency, while lower interest rates can lead to the outflow of foreign currency. This affects the exchange rate of Indian rupee.
- Exports and imports:
- Exports and imports affect the exchange rate as exports earn of foreign currency while imports require payments in foreign currency.
- Thus, if the overall exports increase, the national currency appreciates, while increases in imports lead to the depreciation of the national currency.
- Apart from above, the Indian foreign exchange market is also affected by factors such as the receipts in the accounts of exports in invisibles in the current account, inflow in the capital account such as FDI, external commercial borrowings, foreign institutional investments, NRI deposits, tourism activities etc.
What is RBI’s role in exchange rate determination?
- RBI plays a very important role in exchange rate determination. It controls the drastic fluctuations in Rupee’s exchange rate. For that, RBI can take various measures:
- In case of a drastic fall in Rupee value, RBI sells some of the dollars from its forex reserves. This is why the RBI’s forex reserves have gone down sharply since the war in Ukraine started in February.
- In case of a drastic rise in Rupee value, the RBI buys an excess amount of dollars (by paying rupees in the market) and adds it to its forex reserves.
Pic Courtesy: Business Insider
Content Source: Indian Express