DEVALUATION OF RUPEE

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Meaning of devaluation of Rupee How currency value is determined? Why any country would want to keep its currency value low? Factors influencing the currency value. Why RBI intervene on Currency valuation? Impact of currency devaluation/ Weakening Rupee: Good for NRIs, Bad for Indian Economy

Meaning of devaluation of rupee

When a currency loses value in the market, depreciation occurs. For e.g. Rupee is the Indian currency. Just like any commodity the Rupee also has a price, the value you pay to exchange a rupee. When the rupee becomes dearer i.e. say Rs.40/$ it is said to have Appreciated (Value) in the reverse case say Rs.50/$ then the Rupee Depreciates (Value).

Indian Rupee per US Dollar

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How currency value is determined?

There are many factors to decide the currencies values. The exchange rates is expressed as a comparison of two currencies, and it varies or is determined by the market forces of supply and demand. This is a basic theory. A currency will tend to become more valuable when its demand is higher than supply. A currency will tend to become less valuable when its demand is less than supply.

Is the currency backed by gold?

The gold standard is a monetary system in which all currency issuance is to one degree or another regulated by the gold supply. To protect the public and guarantee the nation against any bankruptcy, the RBI keeps a certain percentage of gold in their own safe deposit vault, in proportion to the additional currency minted and directed into the circulation. The quantum percentage of gold kept in the deposit is not exposed in any documents or in the Websites of RBI or the Government of India.

In what conditions RBI would print currency ?

If currency is soiled or to increase liquidity RBI will initially lessen the interest rates Even if the situation is not controlled, RBI uses its cash reserves to buy domestic bonds ,

This will inject liquidity in the market

Even then if there is a need for RBI to print more currency then it has to maintain gold or forex reserve in proportion to the amount of printing money.

If they have sufficient reserves its fine or else it has to borrow gold or forex from World Bank.
Now, this loan from World Bank will be shown as deficit in our Balance of Payment since it needs to be paid back

Major Factors Influencing the Currency Value

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Inflation Differentials in Interest Rates Current Account Deficits Dollar is in Demand Collapse of international trade Relaxing caps on ECB, FII etc. Stock market performance

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Public debt Terms of trade Political Stability and Economic Performance Transaction demand for money Speculative demand of the currency

1. Inflation
Less Inflation

would mean rising currency value

Investors prefer to buy currency which has a good value Increases demand for a powerful currency
When a currency is in demand/demand is more than supply, its exchange rate becomes good.

2. Differentials in interest rates

Higher interest rates

Offers attractive return to lenders

Attracts foreign capital

Supply of dollars increase/ Demand of Rupee increases

Rupee appreciates/ exchange rate gets better

3. Current account deficits

More current account deficit Mean more imports and less exports

Need more foreign reserves to make payment

Increased demand of foreign currency Rupee depreciates/ exchange rate unfavorable

4 Dollar is in Demand
India is an emerging economy, so a huge percentage of investment in India is from outside the country, especially from US but due to recession in US, big institutions are collapsing and many of them are on the verge of breakdown. Therefore, to recover losses in their country, they are pulling out their investments from India. Due to this pulling out of investment by these big companies from India or in other terms disinvestment, demand of dollar is raising up and rupee is depreciating.

The crude oil prices are increasing which are in turn appreciating dollar as demand for dollar is increasing

5. Collapse of international trade

One can observe uncertain Economic Situation around the globe. The fall of the Indian Rupee was started initially owing to the European debt crisis which led to withdrawing of foreign investment from the Indian market in order to manage the liquidity crisis in their markets. The markets all over the world crashed and the Indian stocks were no exception to the volatile situation. Hence dollars are moving out of our country, which has depreciated rupee.

FII's turning Net-Sellers and withdrawing funds from the Indian Market.
In uncertain times, investors prefer to cash over risky financial assets such as stocks, global sell-off in stocks has increased demand for dollar and led to its appreciation...

6 Relaxing caps on ECB, FII etc.

In the recent times India has opened doors for debt capital by relaxing caps on ECB, FII etc. India's overall external debt outstanding as of June2011 was $317 billion, an increase of 38 per cent in last two years. One worrying factor is that much of the debt is maturing in next one year. Due to re-capitalization needs of European banks, it is likely that these banks will be less forthcoming in refinancing Indian corporate debt. All this is pushing pressure on rupee and has increased demand for dollar which is depreciating rupee..

7. Stock market performance

Overseas investors pouring in money into developing economies Demand for Rupee will increase/Supply of dollars has increased Rupee appreciates

In the same way, if they are pulling out of the market the rupee will depreciate.

8. Public Debt
Countries have to pay for public sector projects and governmental funding Which results in nations large public deficits To meet the deficit govt. will either sell domestic bonds, increase the money supply or sale securities to foreign players on less cost This will Increase the supply of currency

Exchange rate will decrease/Depreciate the currency

9. Terms of trade
A ratio comparing export prices to import prices If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favorably improved

Increasing terms of trade shows greater demand for the country's exports.
This, in turn, results in rising revenues from exports Meaning increased supply of dollars/ increase in demand of rupee Exchange value of rupee gets better/ appreciates

11. Political Stability and Economic Performance

Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital.

12. Transaction demand for money

The transaction demand for money is highly correlated to the country's level of business activity, gross domestic product (GDP), and employment levels. The more people there are out of work, the less the public as a whole will spend on goods and services.

13. Speculative demand

The speculative demand for money is much harder for a central bank to accommodate but they try to do this by adjusting interest rates. An investor may choose to buy a currency if the return (that is the interest rate) is high enough. The higher a country's interest rates, the greater the demand for that currency.

Speculation may also play a part in influencing exchange rates especially of smaller economies where buying or selling huge volumes of the currency can have a marked if temporary impact on the exchange.

Why RBI intervene on Currency valuation?

RBI would not allow currency to be higher after certain level because of the exports would get affected like IT companies would suffer if the rupee gets appreciated against the dollar. In the decreasing rupee scenario, the outgo of money (via imports )will be much higher.

Impact of currency devaluation

Weak Rupee: Good news for: 1. NRI 2. Exporters 3. Improving the trade balance 4. Attract more foreign domestic investment

Rupee depreciation benefits some but not good for the Indian economy.
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Rising prices of imports Rising prices of oil Rising prices of consumer durables Weak rupee forces petrochemical firms to increase prices Increase the burden of servicing and repaying of foreign debt of the Indian Government (which has dollar denominated debt) and those companies that have raised dollar denominated debt

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Depreciating currency might dissuade foreign institutional investment (FII) from investing in the country.