Have you ever wondered how the value of the Rupee moves every day with respect to Dollar? There’s a famous theory in International Finance that states that currency values are random. That is to say, their movements do not have a logic and hence, cannot be predicted.
But the general understanding otherwise is that currency rates go up and down due to two basic factors in Economics that you might have already heard of: Supply and Demand. Whenever more people in the world demand for more Dollar in exchange for Indian Rupees, the price will move upwards. When this happens, we say that the Indian Rupee is depreciating against the Dollar (Or that the Dollar is appreciating against the Indian Rupee). When the demand for Dollar fall, the price of one Dollar moves downwards. When this happens, we say that the Indian Rupee is appreciating against the Dollar (or that the Dollar is depreciating against the Indian Rupee).
Now, what drives demand and Supply? Let’s have a look at the various factors:
Differentials in Inflation
Typically, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. Those countries with higher inflation typically see depreciation in their currency about the currencies of their trading partners.
Differentials in Interest Rates
Interest rates, inflation, and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise.
Current account deficits
The current account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest, and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products.
Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason being a large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future.
Terms of Trade
A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favourably improved. Increasing terms of trade shows' greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency.
Strong economic performance
Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries.
A look back at the past
The Big Deal of 1991
In 1991 there were large scale reforms like removing import quotas, export subsidies and so on. Due to all this, the rupee devalued by 20% almost instantly. This economic crisis happened because the government had a balance of payment problem. Constant delays brought it on the verge of defaulting. The rupee’s value went down to Rs 25/$. After the liberalisation of the economy, Indian Rupee went down to Rs 35/$. Another reason for this problem was the open market that had taken control of its exchange.
The 90s and the 2000 dotcom bubble
The rupee rapidly reached 40 levels in 1998, even as India detonated nuclear bombs and got economic sanctions in return. This meant the rise of the new software/IT exporters, who at Rs. 40 to a dollar were ludicrously profitable. The dot-com bubble took down world economies and India got hit as well. By 2002, the dearth of capital had taken the USDINR to 48. As the Indian economy started to move back in 2002, and liberalised further, allowing foreign investors to buy Indian stocks, the dollar rate started to decline. Inflation was low too, in India. In the next 6 years, the rupee fell back to below Rs. 40 to a dollar.
The Lehman Crisis of 2008
The financial world shut down in 2008 due to the Lehman Crisis. Crude prices first went to $140. The rupee couldn’t handle the rising import cost (crude/gold) and the outflow of dollars (foreign investors exiting) which led to a rate of 51 on the USD INR. This again made the rupee attractive for exporters, and it ended the decade around the 45 levels. This was an incredible decade. The 2000-2010 era, the “noughties”, saw the rupee start in the mid-40s and ended in the mid-40s, seeing 38 on one side, and 51 on the other.
The 2011 and 2013 spurts in the dollar
Inflation in India was very high. Compared to the US or the west, who could kill for any amount of inflation, India saw near double-digit inflation, and the rupee took it on the chin, first crossing 50 in 2011.
India saw a sudden move, in July and August 2013, where the rupee went straight to Rs. 68. Bankers in India pushed Raghuram Rajan to create an RBI guaranteed NRI fixed deposit to stabilise the rupee. RBI would lend banks rupees at a 3.5% interest rate if they gave the RBI dollars taken from new NRI deposits. The exchange rate was guaranteed, so they would max see a devaluation of 3.5% per year. Interest rates were at 9%, so the banks could offer dollar returns of 5.5% per year. The “taper-tantrum” ended soon, and we the rupee fall to below Rs. 60 on the USD.
Cut to 2018: 72
We were close to 72 in 2018. The slide was about all emerging markets sliding against the dollar. The Rouble was down by 20%, the Brazilian Lira 25% and the Turkish Lira was off the chart. India was only 11% down in a year. But that’s the highest as an annual change since the taper tantrum.
The rupee depreciated by 6 paise to 70.98 against US dollar in early trade on 1st November 2019, as the weak macro environment and rising crude prices kept investors edgy. A weak dollar against major currencies overseas, persistent foreign fund inflows and a positive opening in the domestic equity market extended support to the rupee. At the interbank foreign exchange market, the rupee opened on a weak note at 70.96 and fell further to trade at 70.98, down 6 paise over its previous close. On 31st October, the rupee had settled with a marginal fall of 2 paise at 70.92. The domestic unit came under pressure after official data released on Thursday showed that the growth of core industries plummeted in September. The output of eight core infrastructure industries contracted by 5.2 per cent in September, the lowest in the decade, indicating the severity of economic slowdown. As many as seven of the eight core industries saw a contraction in output in September.
IFA Global expects the rupee to trade in the range of 70.55-70.90 in the near term. State-run banks may continue to accumulate USD around 70.50 levels. The overall global risk sentiment continues to remain positive on hopes that the US and China would be able to clinch a trade deal soon. This has benefited emerging market currencies including the rupee.
The future of the Indian rupee is going to be determined by the ramifications of the US-China Trade War. This is one of the most important global factors impacting the rupee exchange rate against major foreign currencies.
The recent set of events such as global economic slowdown and the US-China trade war have led to weakening in demand for crude oil which is expected to further soften the prices. Further, the production cut decision of the OPEC has been negated by an increased supply of US shale oil. The recent decision of the USA of imposing an additional 10% duty on the import of Chinese goods, has further escalated the trade war with no signs of trade settlement in the coming times. This would not only negatively affect the global growth scenario but also exert currency depreciation pressure on major Asian currencies, including the Indian Rupee.
Crude oil prices have been in the range of $60-70 a barrel for quite some time have had an appreciating effect on the rupee exchange rate. If the geopolitical situation in the middle-east region remains stable, crude prices are expected to fall further to $55-60 range with the escalation of the trade war. Any fall in crude oil prices from hereon will have a cushioning effect on the USD-INR exchange rate. Announcements made in the Budget 2019 are expected to have a lingering effect on the rupee exchange rate. The additional surcharge imposed on Foreign Portfolio Investors (FPIs) who are not registered as companies have led to heavy selling by FPIs in the equity market.
If the FPI surcharge issue is not resolved soon and the debt market turns unfavourable to
FPIs in terms of net returns, the rupee may come under immense pressure.
The forecast by dollarrupee.in expects rupee to depreciate further and trade at a price of Rs. 77 per 1$ by 2021-year end.