Ever wondered why the rupee quotes at 53.2 or 50 and not at Rs. 20 or Rs. 80 to a dollar?
It’s not much different from how the prices of your mangoes are
determined, for example. Whether currency movements or prices of
mangoes, the most important factor determining their price is the same –
market forces of demand and supply.
If the demand for dollars increases, the value of dollar will
appreciate. As the quotation for Rs/$ is a two way quote (that is, the
price of one dollar is quoted in terms of how much rupees it takes to
buy one dollar), an appreciation in the value of dollar would
automatically mean a depreciation in Indian rupee and vice-versa.
For example, if rupee depreciates, a dollar which once cost Rs. 47 would cost, say, Rs. 50. In essence, the value of dollar has risen and the buying power of rupee has gone down.
Besides the primary powers of demand and supply, the rupee-dollar rates are determined by other market forces as well.
Market sentiments
During turbulent markets, investors usually prefer to park their money
in safe havens such as US treasuries, Swiss franc, gold and so on to
avoid losses to their portfolios. This flight to safety would lead to
foreign investors redeeming their investments from India. This could
increase the demand for dollar vis-à-vis Indian rupees.
Speculation
There are derivative instruments and over-the-counter currency
instruments through which one can speculate/ hedge the underlying
currency rates. When speculators sense improvements/ deterioration of
the sentiments of the markets, they too want to benefit from such
rising/ falling dollar. They then start buying/selling dollar which
would further change the demand/ supply of the dollar.
RBI Intervention
When there is too much volatility in the rupee-dollar rates, the RBI
prevents the rates from going out of control to protect the domestic
economy. The RBI does this by buying dollars when rupee appreciates too
much and by selling dollars when the rupee depreciates significantly.
Imports and Exports
Ever give thought as to why our government is trying to incentivise
exports and reduce imports? There are a lot of schemes and incentives
for exporters while importers are burdened with many conditions and
taxes. This is to protect our economy from high rupee depreciation.
Importing foreign goods requires us to make payment in dollars thus
strengthening the dollar’s demand. Exports do the exact reverse.
Public Debt / Fiscal policy
Whenever our Government fails to match expenses with equivalent revenue,
there is a shortage of funds. To finance this, the Government at times
opts to borrow money from institutions such as the World Bank and the
IMF. This debt, accrued interests, and the payments made, also lead to
currency fluctuations.
Interest Rates
The prevailing interest rates on the government bonds attract foreign
capital to India. If the rates are high enough to cover the foreign
market risk and if the foreign investor is comfortable with the
fundamentals or credit ratings, money would start pouring into India and
thus provide us with a supply of dollars.
Thanks to
(The writer is Senior Vice President, Bonanza Portfolio Ltd.)
http://www.thehindubusinessline.com/money-wise/how-rupeedollar-rates-are-determined/article4629962.ece
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