Falling rupee, rising tensions

The rupee closed at a record low of 53.97 to the US dollar on Monday, hammered by global economic concerns, rising domestic prices and falling expectations on interest rate cuts. A look at what it is and could do.

The rupee closed at a record low of 53.97 to the US dollar on Monday, hammered by global economic concerns, rising domestic prices and falling expectations on interest rate cuts. A look at what it is and could do.

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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, value of the rupee has fallen or depreciated from about Rs. 50 to a dollar to about Rs. 54 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 the changing demand and supply situation.

Why is the rupee falling?
Foreign institutional investors (FIIs) are cashing out and diving into safer investment bets such as US government bonds due to policy uncertainties such as General Anti-Avoidance Rule (GAAR).

This is making dollars scarce and reducing demand for rupees. The spurt in crude oil prices has also pushed up demand for dollars for the import of crude oil.

What's in it for 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, prompt oil companies to hike petrol and diesel prices.

Costlier transport fuel will knock up 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 I 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. 600,000 (at 50 to a dollar) for a $12,000 course in an overseas university, now the cost will go up to Rs. 648,000 (at 54 to a dollar) even though the fee in dollar terms remains unchanged. So, your study loans might go up.

Does foreign travel get affected?

If you are planning an overseas vacation, you better set aside more money. A weaker rupee implies you end up paying more to buy dollars to pay for your air tickets, hotel tariffs, shopping and other expenses.

A hotel room that costs Rs. 10,000 ($200) a night (at 50 to a dollar ) will now cost you Rs. 10,800 (at 54 to a dollar), even though the tariff in dollar terms remains unchanged forcing you to buy more foreign exchange before you head out for the vacation.

How is it going to impact exporters?
If you are an exporter, a weaker rupee would mean your earnings in rupee terms will go up. But slowdown in European Union, India's biggest export market, may force orders to dry out.

Will it affect Indian companies?
The slide in the rupee will hurt profitability of many companies. Companies that borrowed dollars from overseas banks will be the worst hit as repaying loans will become costlier.

Imported raw material such a copper, aluminum and machinery will turn costly and squeeze profit margins. This may prompt companies to raise prices of consumer goods such as cars and televisions.

What policy options are used to stem the rupee's fall?
As the country's central bank, the 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.