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Why Rupee’s Fall To 20-Month Low Should Not Worry You

By News Canvass | Dec 19, 2021

Currency fluctuations are a natural outcome of floating exchange rates, which is the norm for most major economies. A currency’s exchange rate is typically determined by the strength or weakness of the underlying economy. As such, a currency’s value can fluctuate from one moment to the next.

Currency Depreciation is the loss of value of a country’s currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system in which no official currency value is maintained. 

Currency Appreciation in the same context is an increase in the value of the currency. Short-term changes in the value of a currency are reflected in changes in the exchange rate.

Economic Effects
  • When a country’s currency appreciates in relation to foreign currencies, foreign goods become cheaper in the domestic market and there is overall downward pressure on domestic prices. In contrast, the prices of domestic goods paid by foreigners go up, which tends to decrease foreign demand for domestic products.

  • A depreciation of the home currency has the opposite effects. Thus, depreciation of a currency tends to increase a country’s balance of trade (exports minus imports) by improving the competitiveness of domestic goods in foreign markets while making foreign goods less competitive in the domestic market by becoming more expensive.

  • In the international capital market, a change in a currency’s value may give rise to a foreign exchange gain or loss. The appreciation of the domestic currency raises the value of financial instruments denominated in that currency, while there is an adverse impact on debt instruments.

How Do Currencies Move?
  • Most exchange of currencies takes place at banks. Currencies issued by different countries move through banks and it are here that most of the transactions take place. 

  • A person in Delhi having legal US dollar bills can get them converted to the Indian rupee at a particular exchange rate at a bank. This bank represents a small unit in the huge Foreign Exchange Market. 

  • The central bank of a country (RBI in India) also maintains a large reserve of foreign currency to deal with any kind of problems for Local currency in the Foreign Exchange Market. As mentioned earlier authorities of a country do intervene when they sense a bad time for their currency. 

  • They do this by adjusting the supply of a particular currency either directly or changing some other factors. As stated earlier, it is the supply and demand that determines the value of a currency. Since controlling the demand is barely in the hands of authority they influence the value of a currency by adjusting the supply of a currency in the market. 

Us Dollar In India Rupee Market
  • The demand for the US dollar is high since India is importing more products from the US than exporting. In such a scenario, the demand for the US dollar will increase since more dollars will be paid to the US while buying goods from them. And from the Indian side, more dollars will have to be bought from Foreign Exchange Market to pay for these goods. 

  • As such demand for US dollars will increase as compared to the Indian rupee and hence their value. But if the value of the Indian Rupee falls a lot, the government will intervene. Immediately, they will try to reduce the supply of the Indian rupees (to compensate for the low demand). They will buy the Indian rupee from the market using US dollar reserves held by it.

  • As it buys more Indian currency using the US dollars, the supply of Indian currency decreases while that of the US increases, leading to an increase in the value of the rupee and a decrease in the value of a dollar. They can also influence the supply using other techniques. In the long run, to sustain one currency at a good value, a country needs to increase the demand for its currency. This is a small example of the process, the actual process works at larger and at many levels. 

  • At the end of the day, it is the demand for a particular currency that determines its value in long run. And this demand is influenced by many factors like fiscal and monetary policies in a country, the amount of trade happening in a country, inflation, peoples’ confidence in the political and economic conditions of a country

Rupee’s Fall To 20-Month Low
  • The rupee plunged by as much as 44 paise to settle at a 20-month low on Wednesday, December 15 2021, as consistent foreign fund outflows and risk-averse sentiments weighed on the local unit. At the interbank foreign exchange market, the local unit breached the 76 level in the opening session to trade lower at 76.05 against the dollar on foreign fund outflows.

  • The domestic unit plunged further to settle at 76.32, a level not seen since April 24, 2020, registering a loss of 44 paise over the previous close. Also, the rupee recorded its sharpest single-day decline in almost eight months.

  • The rupee has been under pressure for the past five weeks due to consistent forex outflows on expectations of a faster rate of tapering by the US Federal Reserve to tackle the rising inflation.

  • The local unit has declined in nine out of 11 trading sessions this month, tanking a total 119 paise or 1.58 per cent against the dollar. The decline in the rupee has also been driven by the fear of the rapid spread of the Omicron variant, according to traders.

  • Due to the exit of foreign investors from the market after signals from the Federal Reserve and increased demand for dollars towards the end of the year, there has been tremendous pressure on the rupee against the dollar. The rupee has fallen to a low of 20 months.

  • In Wednesday’s trade, the rupee was under pressure from the beginning. At the end of trading, this pressure increased further, after which the rupee closed at 76.28 with a weakness of 40 paise. This has been the weakest level of the rupee since 24 April 2020. The biggest reason for the weakness in the rupee is the selling of foreign investors. FPIs were also net sellers on Tuesday and they sold

What Will Be The Effect Of Weakness In Rupee
  • Extra payment will have to be made on the expenses of travelling abroad with a weak rupee, studying in a foreign university or any other service taken from abroad.

  • Not only this, in order to meet the need, petroleum products, mobile phones, edible oil, pulses, gold-silver, chemicals and fertilizers are also imported in India, that is, due to the weakening of the rupee, all of them become expensive.

  •  The fear has increased. At the same time, the effect of fall in crude oil will also reduce. That is, if you are expecting petrol to be cheaper due to reduction in crude oil, then your hopes may be broken due to weak rupee.

Weakness Of Rupee Also Has Advantages
  • The weakening of the rupee not only has disadvantages, but also has some advantages, such as a weak rupee makes the goods imported from abroad expensive. In the same way, good money is also available for goods going from India to foreign countries.

  • Simply put, if you have to pay more rupees for dollars, then in return you will get more rupees for dollars.

  • That is, a weak rupee is beneficial for those who export goods or services from the country. Products like parts, tea, coffee, rice, spices, marine products, meat are exported from India and exporters of all these will benefit from the weakening of the rupee.

Some Insights
  • There is a broad weakness across Asian markets ahead of the US Fed’s meeting that may announce an accelerated pace of liquidity tightening

  •  A tapering by US Fed will lead to an outflow of fund flows from emerging markets. The inflation in the US has risen to a multi-decade high, posing a risk for the Fed to act sooner than expected.

  • The weakness in the rupee is despite record RBI reserves of around $640 billion. The central bank has added over $60 billion in forex reserves in FY22. The latest retail inflation data in India hit a 3-month high.

  • The next few days will be dominated by US Fed, ECB, and BoJ as they meet to decide on their respective monetary policy. Central banks’ action on rate, liquidity, and the resolve to aid recovery in growth rate will guide global equities and currencies.

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