As humanity evolved, a need for an efficient method for trading evolved. Initially, people used to trade what they wanted for what they had an excess of, however, this started causing trouble when two people wouldn't be able to come to a barter due to a difference in interests and so, what once started with the barter system morphed into our current paradigm of currencies. Today, almost every country has its own currency. These currencies act like tokens for people who want to buy or sell something, but then how do currencies from two separate nations correlate to each other? In this article, we’ll be focusing on one such instance. Today we will be studying all about the Rupee-Dollar fluctuation.
The Rupee or the rūpiya is the Indian unit of currency. It was founded and standardised by Sher Shah Suri of the Suri empire between 1540 and 1545. The rupee still functions as the standard monetary unit of India. However, the rupee seems to have always fallen short of the American currency unit of dollars during currency conversion. The cause for this can’t be summarised with just a few sentences, rather requiring an in-depth analysis in and of itself.
The Rupee-Dollar fluctuation and what causes it
There are a few factors that affect the value of a currency when in comparison to other currencies. These are:
- Foreign exchange rates,
- Foreign reserves,
- The balance of trade,
- The demand for goods from that country, and
- That country’s economy.
It is here that the Rupee-Dollar rate is determined. The foreign exchange rates rely heavily on the demand for a particular currency. Foreign exchange dealers put a value on the dollar on the basis of its demand and the supply. Given a high demand for the dollar, these dealers buy a large number of dollars against Indian rupees at a certain rate, and then they try to sell these dollars off for a higher bid in an attempt to maintain a profit margin. This is why the rupee-dollar rate tends to fluctuate throughout the trading day.
Another factor that heavily affects the conversion value of a currency is the amount of that currency owed by foreign governments. India has a huge amount of debt owed to the United States and this reflects in the value of the Indian Rupee versus the American Dollar. This debt has only climbed over the years, going from 1,160.56 billion dollars in 2014 to 1,801.98 billion dollars in 2018. This is in accordance with the fluctuation of the rupee against the dollar. This debt is projected to grow even more to 3,299.94 billion dollars by 2024.
The balance of trade is yet another aspect to be considered while evaluating the trade value of a currency. A country that buys more than it sells to other countries will not be able to balance the inflow and outflow of foreign exchange in their country, therefore making their own currency weaker. This is particularly true with respect to the trade between India and other countries. We buy more from other countries than we sell to them. This has significantly weakened the value of the Indian Rupee.
The demand for goods from a country factors in significantly in the strength of its currency. This is particularly true in cases such as that of Saudi Arabia. Crude Oil from Saudi Arabia is in major demand across the world. If Saudi Arabia starts selling crude oil for Riyal, people will start buying more and more Riyal in order to buy crude oil. This will make the Saudi Riyal very expensive in comparison to other currencies. However, the Saudi economy will not be able to manage the shock of this sudden increase in value and therefore, Saudi Arabia sells crude oil in US dollars. This has lent to the high foreign exchange values of the American dollar.
Finally, the last major factor that affects the Rupee-Dollar fluctuation is the country’s economy. If a country’s economy is considered safe, people tend to invest in that country’s currency in order to safeguard their wealth. This is the case with dollars and euros as Indians tend to convert into dollars in order to keep their wealth intact through the volatility of the Indian economy.
There are a lot of ways a weakened Rupee can affect India. The impact of this phenomenon can be felt by the entire country. There are a lot of ways a decline in the exchange rate of rupee has affected the daily life of Indian citizens. A few of them are:
- Higher Price of Imported Goods: A decline in the rate of the currency leads to a higher landing cost for most imported goods such as gold, crude oil, or other raw products. This, in turn, translates to an all-around increase in the rates of many finished goods across the Indian market.
- Impact on Trade: A weakening of the currency makes it even more expensive for merchants from India to export their products outside. This leads to a widening of the gap between our imports and our exports. That, in turn, unbalances the already unbalanced trade of the country even further, increasing our trade deficit. This, in turn, makes our currency weaker.
- Effect of GDP: A weakening of the currency increases the input of companies leading to lower profit margins. This affects our short-term growth and thus, impacts our GDP.
- Impact on the Current Account and the Capital Account: A decline in the conversion rate of the rupee against the Indian Dollar leads to a widening of both our current account deficit (CAD) and our capital account deficit as it increases the price of imports while also increasing the revenue off of exports in rupees.
- Impact on Investors: India has been seen as one of the most attractive avenues for foreign investments since the early 2010s. This translated well for our economy, leading to a miraculous rise in the Sensex. A lot of job opportunities were created, and the country as a whole developed further because of the sudden influx of foreign investments. However, a depreciating rupee brought this trend down. The sudden uncertainty in the Indian market scared off a lot of investors, thus affecting the growth of the entire country.
Therefore, these fluctuations in the rate of rupee against that of the dollar wreak havoc on the Indian economy, leading to more and more inflation across the country. This forces banks to change their policies to accommodate the needs of the Indian economy while also putting Indian businessmen out of jobs.
In a country like India, imports cannot be avoided. However not all hope is lost for the country. India still remains the golden land for foreign investments. An improvement in the economy aided by an improved capital inflow from foreign investments will surely improve the scenario for the Indian Rupee. The Reserve Bank of India can take steps to ensure a consistent inflow of Foreign Direct Investments and Foreign Institutional Investments.
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Q. How has the Rupee-Dollar exchange rate been affected by the Coronavirus pandemic?
A. An observation conducted by Exchange Rates UK indicates massive fluctuations in the conversion rate of the Indian Rupee against the American Dollar between February 25th and August 21st. This study shows a sudden spike in the rate of dollars against rupees in the second quarter of 2020. This has heavily affected the financial conditions of our country, putting an even heavier burden on traders and companies all across the nation.
Q. How does a depreciating currency affect the rate of interest of a country?
A. The interest rates of a country and the strength of its economy are deeply tied together. A higher rate of interest in India leads to more inflow of capital in the country as the investors will receive better returns. A depreciating Rupee creates the need for a higher rate of interest in order to try and minimise the variation in the value of the Indian Rupee.
Q. Why can’t we just mint more money to make up for the financial conditions of the country?
A. While this may sound very sound in theory, it is actually very dangerous in practice. A currency is nothing but a token for the exchange of goods or services in a country. Blinding minting more money will just weaken the currency even further as the number of goods offered by the country will not change. Take Zimbabwe's case for instance. Since the 1990s, production gradually declined in Zimbabwe but the government kept printing more and more notes. This took a heavy toll on the country's economy to the point where 1 dollar became equal to 35 quadrillion Zimbabwean dollars. People finally lost faith in the local currency and started using the American dollar instead.