What is an exchange rate? Are terms like managed float, dirty float, fixed exchange rates, floating exchange rate, pegged exchange rate, crawling peg the same? Which type of exchange rate regime does India follow? What is a currency crisis? In recent times the rupee is becoming weaker against the dollar every day, what are the reasons for the same and what steps is the RBI taking to control the same. So, is the rupee depreciating or devaluing against the dollar? Support your conclusion by giving a dollar rupee graphical trend for the last three months.
Exchange rate is a key determinant in international finance and turning of world into a global village has just made this variable all the more important. An Exchange Rate is the price or rate between two countries at which the one country's currency will be exchanged for the other country's currency. It is also known as the value of one country's currency in terms of other country's currency. Exchange rate is also called Foreign Exchange Rate, Forex Rate or FX Rate.
There are many factors that influence the exchange rate, such as interest rate, inflation, stock markets, political unrest, Government budget deficit/surplus, balance of trade and the economy on the country. The exchange rate is used to simply convert one currency into another.
For Example:-
An interbank exchange rate of 55 INR (INR, Rs.) to the United States Dollar (US$) means that Rs 55 will be exchanged for each US$1 or that US$1 will be exchanged for each Rs 55.
Some of the Currency Exchange Rates are as follows:-
US Dollar
1.00 USD
inv. 1.00 USD
Euro
0.781887
1.278957
British Pound
0.624393
1.601556
Indian Rupee
55.391176
0.018053
Australian Dollar
0.962320
1.039156
Canadian Dollar
0.977979
1.022517
Emirati Dirham
3.673202
0.272242
Swiss Franc
0.945141
1.058043
Chinese Yuan Renminbi
6.343852
0.157633
Malaysian Ringgit
3.112500
0.321285
New Zealand Dollar
1.231449
0.812052
Type of Exchange Rate Regime
An exchange can operate under four types of exchange rate systems which are as follows:-
Fully Fixed Exchange Rates: - In a fixed exchange rate system, the government (or the central bank acting on its behalf) intervenes in the currency market in order to keep the exchange rate close to a fixed target. It is committed to a single fixed exchange rate and does not allow major fluctuations from this central rate.
Semi-Fixed Exchange Rates: - Currency can move within a permitted range, but the exchange rate is the dominant target of economic policy-making. Interest rates are set to meet the target exchange rate.
Free Floating Exchange Rates: - The value of the currency is determined solely by supply and demand in the foreign exchange market. Consequently, trade flows and capital flows are the main factors affecting the exchange rate. The definition of a floating exchange rate system is a monetary system in which exchange rates are allowed to move due to market forces without intervention by national governments. The Bank of England, for example, does not actively intervene in the currency markets to achieve a desired exchange rate level. With floating exchange rates, changes in market supply and demand cause a currency to change in value. Pure free floating exchange rates are rare - most governments at one time or another seek to 'manage' the value of their currency through changes in interest rates and other means of controls.
Managed Float Exchange Rate: - A floating exchange rate in which a government intervenes at some frequency to change the direction of the float by buying or selling currencies. Often, the local government makes this intervention, but this is not always the case. For example, in 1994, the American government bought large quantities of Mexican pesos to stop the rapid loss of the peso's value.
A central bank's intervention to raise or lower interest rates could be considered a managed float. However, because most floating currencies manage their regimes with occasional central bank involvement, the term applies mainly to frequent or dramatic interventions. A managed float is also known as a dirty float.
Crawling Peg: - A system of exchange rate adjustment in which a currency with a fixed exchange rate is allowed to fluctuate within a band of rates. The par value of the stated currency is also adjusted frequently due to market factors such as inflation. This gradual shift of the currency's par value is done as an alternative to a sudden and significant devaluation of the currency.
Exchange Rate Regime: India Follows
India follows the Managed Float Exchange Rate System. This means that the Indian government intervenes only if the exchange rate seems to go out of hand by increasing or reducing the money supply as the situation demands.
Currency Crisis..???
Currency Crisis is sudden decline in the value of the country's currency caused by the balance of trade or balance of payments deficit which negatively affects the economy and attacks the foreign exchange market. It happens when the value of currency changes frequently and is a type of financial crisis. Currency crises can be destructive to small open economies or bigger, but not sufficiently stable ones. Governments often take on the role to mitigate such attacks by satisfying the excess demand for a given currency using the country's own currency reserves or its foreign reserves.
Some of the Examples for currency Crisis are Economic Crisis in Mexico in 1994, Asian Financial Crisis in 1997, Russian Financial Crisis in 1999 etc.
Rupee (INR) Vs US Dollar (US $)
In the past few months the Indian Rupee has been losing its momentum continuously. The rupee-dollar exchange rates crossed the sensitive 50 mark sometime last year, raising fears among many foreign investors and importers alike. Earlier this month, the rupee created more nervousness by hitting an all-time low of 55.27. While a weak rupee is good for some sectors, it may be bad for the Indian economy on the whole.
The general perception among experts is Indian Rupee will continue to crumble till the global situation continues to remain uncertain. The global events have a bearing on the entire globe, including India.
Reasons why Indian rupee is falling against Dollar..????
Measures or Steps taken by RBI to tide and control the high exchange rate of Dollar versus Rupee…??
With the intervention of RBI, there is a hope that risk aversion and concerns about India's economic and fiscal challenges will come to an end.
The central bank directed exporters to convert up to 50% of their foreign currency holding with banks into rupee balances within a fortnight, a move that will bring at least $2.5 billion into the market, lending support to the rupee.
In order to attract FII, RBI has increased interest rate on the deposits.
RBI have also eliminated $100 million cap on rupee swap transaction that is undertaken on behalf of the customers.
RBI reduced the lock-in period of investment to three years from five for foreign investment in government bonds for up to $10 billion, including the additional $5 billion.
The RBI said manufacturing and infrastructure companies can raise money overseas via external commercial borrowings by an additional $10 billion to meet capital expenditure and repay rupee loans.
If the country has high fiscal deficit and high inflation, and also has high current account deficit, I don't see why the currency will not depreciate.
The Key reason for this would be the global economic scenario. The economic situation, over the world is volatile. People are worried about the safety of their investments. People still believe that the US Dollar is much safer than any other currency in the world and hence are accumulating the US Dollar. This effectively means that, the demand for the Dollar is going up which essentially means the price of other currencies may be affected. Because of risk aversion on the part of people, US Dollar regained its place as a Safe Haven.The sharp depreciation over the past three months has added to pressure on policymakers to take decisive action to boost investment.
Is this Good News or Bad News…??
Well, the answer is different depending on who you are.
Good News If: -
1. You are an IT company like Infosys or TCS. Most of your revenue comes from USA and is in US Dollars. So, if the Rupee Depreciates, you earn more in terms of Indian Rupees even though, the US Dollar amount you get paid is the same.
2. You are someone working in United States of America. You send money to India for your family or investment. So, you are going to get more rupees for the same amount. For example, if you send USD 1000 every month to your parents, they would have got around Rs. 45000/- every month last year and now they will get Rs. 52000/-
3. You are a Manufacturer who exports stuff to USA or any other foreign country and get paid in US Dollars.
Bad News If: -
1. You are an Oil Company like Indian Oil or Bharat Petroleum. Since the price of oil is determined on a per barrel basis in USD, for the same barrel of oil, you end up paying more in terms of rupees
2. You are a manufacturer who imports stuff from other countries for your manufacturing. Not all stuff you want for your production is available in India. If your work has importing stuff from abroad, you might incur extra expenses in procuring the stuff you want
Graphical Trend (INR/USD of past three months)
Graphical Trend (INR/USD of last 5 days)
On the Whole…..
This is more Bad News for the General Public. The price of oil and other materials which are imported from foreign countries are going to go up. This essentially means that Petrol, Diesel and other items are going to cost more. Already Petrol has crossed the Rs. 70/- per litre and the rupee depreciation may affect the situation further and drive the prices of petrol & diesel even further. This will mean that all items like vegetables, fruits, any and all items that are transported from one place to another before they are sold will get costlier. The cost of moving stuff from place to place is going to go up and the manufacturer/producer is going to pass on the extra cost to the end customer - "You and Me". So, as a whole this is REALLY BAD NEWS!!!!
Viper Report
