The forex puzzle

With the rupee plunging to new depths, a primer on currency markets and the way ahead. Here is Gaurav Choudhury providing some insights on how to brace yourself for what is about to come.

business Updated: Jun 11, 2013 23:41 IST
currency market,exchange rate,rupee falling

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 is 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 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 changing demand and supply situation.

Why is the rupee falling?

The US economy is showing signs of recovery; so, global investors are withdrawing money from emerging economies. The central bank of US, The Federal Reserve, is likely to withdraw easy monetary policy, which will take out money from countries such as India. Besides, high demand for gold and high crude oil import is increasing demand for dollars

How will the unwinding of monetary stimulus in the US affect India?

The third round of quantitative easing (QE) by the Fed, will impact India in a number of ways. It involves a purchase of bonds by the Fed to pump in loads of cheap money ($40 billion or about Rs 2.3 lakh crore each month) into the financial system to help the American economy claw out of its worst decade since the Great Depression.

With the US — that represents about a quarter of the world’s economy — showing early signs of turnaround, there are signals that the Fed may start rolling back this stimulus package, effectively taking out funds from emerging countries such as India.

In India, analysts believe that a reduction of QE purchases would be very negative in the short-term, but should bode well over the medium term. Net capital inflows totaled $88 billion (Rs 484,000 crore) in 2012, largely aided by global quantitative easing. With the current account deficit (CAD) likely to be almost $100 billion (Rs 588,000 crore) in 2013, a reversal of capital inflows would likely pull down the rupee making the financing of CAD difficult. All in all, this could delay a growth recovery in India.

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, prompting oil companies to hike petrol and diesel prices. Costlier transport fuel will increaseprices 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 R6 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 Rs 54 to a dollar) even though the fee in dollar terms remains unchanged. So, your study loans might go up.

What about foreign travel?

If you were 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 Rs 50 to a dollar) will now cost you Rs 10,800 ( at Rs 54 to a dollar), even though the tariffs in dollar terms remains unchanged, forcing you to buy more foreign exchange before you head out for the vacation.

What about exporters?

If you are an exporter, a weaker rupee would mean your earnings in rupee terms will go up. But slowdown in the EU, India’s biggest export markets, may force orders to dry out

How will it affect companies?

The slide in rupee will hurt profitability of many companies. The 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?

The country’s central bank Reserve Bank of India (RBI) has a responsibility to prevent economy from currency shocks. The 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.

First Published: Jun 11, 2013 22:23 IST