The rupee hit a record low of 61.21 on Monday. A primer on currency markets and the options available to the RBI and the government to stem its fall.
How does the currency market operate?
Like any other commodity, the exchange rate or price of a currency is determined by the laws of demand and supply. A stronger demand for the currency will push up its price and vice versa.
What’s an exchange rate?
The exchange rate gives price at which currencies of different countries are bought and sold. An exchange rate of Rs. 50 to a dollar simply means that the value of one US dollar is equivalent to Rs. 50.
What does appreciation and depreciation of currency mean?
If a currency is depreciating, it implies that its value has fallen in relation to another currency. In the present context, the value of rupee has fallen or depreciated from about R53 to a dollar to about R61 in a little over two months.
Why does the exchange rate fluctuate every day?
Banks, corporations, brokers, individuals and governments buy and sell currencies every day. That explains the daily fluctuations in the currency prices according to changing demand and supply situation.
What policy options are used to stem the rupee’s fall?
As the country’s central bank Reserve Bank of India (RBI) has a responsibility to prevent economy from currency shocks, central banks world over intervene through buying or selling of currencies through banks. To prop up a weak rupee, the RBI sells dollars in the market.
How does RBI sell dollars to oil companies directly?
The rupee’s persistent downward spiral has sparked off speculation that the RBI will implement a fresh set of measures including allowing oil companies to buy dollars through a special window and not in currency markets — a move aimed at easing the persistent pressure on the rupee. In another method, the RBI can offer to buy bonds from oil firms, giving them dollars or other currencies in return that they can use to purchase crude oil from global markets.
What is moral suasion?
Sometimes central banks or monetary authorities convince banks and financial institutions to carry out certain acts through non-official persuasion as opposed to official instructions or statutory decree. It’s often described as “suasion” and used to nudge banks to stick to guidelines that are not officially handed out. The ‘moral’ aspect derives itself on the invoking banks’ ‘moral responsibility’ towards issues that have wider national importance, rather than focusing solely on commercial interests. Such methods are described differently in different countries. In it is also known as ‘window guidance’ and in the US, it is known as ‘jawboning’.
How is moral suasion relevant in the context of the recent fall in the rupee?
In the current context, the RBI can use moral suasion to persuade banks and financial institutions to raise cheaper dollar-denominated funds from overseas markets and then lend these to domestic borrowers in the form of rupee loans.
What other methods can authorities apply to attract dollars?
The government can decide to float a sovereign bond that will allow the government to dig deep into the pockets of foreign pension and institutional funds to stem the rupee’s slide, raise funds for building highways and also test international investors’ confidence in a slowing economy that has been the target of unsparing criticism from global credit rating firms. The Resurgent India Bond (RIB) 1998, and the India Millennium Deposit (IMD) 2000 were also similar bonds targetted at channelising NRI savings into India, but were of much shorter tenure of five years. The RBI can also decide to ask banks to limit their net overnight open position limits to prevent speculative trading. In a more extreme case, the RBI can decide to make import payments in a staggered to prevent a persistent drain on forex reserves.
What are the latest factors that are hammering down the rupee?
Strong jobs data in the US that showed strong signs of a turnaround in the world’s largest economy prompted foreign funds to withdraw money from emerging economies’ currency and equity markets amid looming signs that the US Federal Reserve will wind down its monetary stimulus programme by mid-2014.
How does the falling rupee affect the economy?
A depreciating rupee will make imported goods costlier. So, expect computers, imported mobile phones and gold to become costlier. It will also make crude oil imports costlier, prompting oil companies to hike petrol and diesel prices. Costlier transport fuel will increase prices of most goods and stoke inflation. A weak domestic currency affects the current account deficit — the gap between export earnings and import payments.
Should you be worried?
You better be, if you have plans to study and travel abroad. A weaker rupee implies you end up paying more to buy dollars to pay for your fees. If earlier you were planning to pay Rs. 6 lakh (at Rs. 50 to a dollar) for a $12,000 course in an overseas university, now the cost will go up to Rs. 6.48 lakh (at R54 to a dollar) even though the fee in dollar terms remains unchanged. So, your study loans might go up.