Devaluation of Rupee

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DEVALUATION OF RUPEE

1.

Meaning of devaluation of Rupee

2.

How currency value is determined?

3.

Why any country would want to keep

its currency

value low?

4.

Factors influencing the currency value.

5.

Why RBI intervene on Currency valuation?

6.

Impact of currency devaluation/ Weakening

Rupee: Good for NRIs, Bad for Indian Economy

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Meaning of devaluation of

rupee

When a currency loses value in the market,

depreciation occurs. For e.g. Rupee is

depreciation occurs. For e.g. Rupee is the Indian

the Indian

currency

currency. Just like

. Just like any commodity the

any commodity the Rupee also

Rupee also

has a price, the value you pay to exchange a rupee.

When the rupee becomes dearer i.e. say

When the rupee becomes dearer i.e. say Rs.40/$ it

Rs.40/$ it

is said

is said to have Appreciated (V

to have Appreciated (Value) in

alue) in the reverse

the reverse

case say Rs.50/$ then the Rupee Depreciates

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Indian Rupee per US Dollar

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Category 1 Category 2 Category 3 Category 4

Series 3 Series 2 Series 1

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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.

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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.

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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

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Major Factors Influencing the

Currency Value

1.

Inflation

2.

Differentials in Interest Rates

3.

Current Account Deficits

4.

Dollar is in Demand

5.

Collapse of international trade

6.

Relaxing caps on ECB, FII etc.

7.

Stock market performance

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Continue….

9.

Public debt

10.

Terms of trade

11.

Political Stability and Economic Performance

12.

Transaction demand for money

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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

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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

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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

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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

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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...

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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

June-2011 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

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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.

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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

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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

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11. Political Stability and

Economic Performance



Foreign investors inevitably seek out stable

countries with strong economic performance in

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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

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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.

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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

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Weak Rupee: Good news for:

1.

NRI

2.

Exporters

3.

Improving the trade balance

4.

Attract more foreign domestic investment

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upee eprec a on ene s

some but not good for the Indian

economy.

1.

Rising prices of imports

2.

Rising prices of oil

3.

Rising prices of consumer durables

4.

Weak rupee forces petrochemical firms to

increase prices

5.

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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6.