10/31/13

Basics explained: Why does the Rupee fall? - Yahoo India Finance

Thu 31 Oct, 2013, 11:38 AM IST - India Markets close in 4 hrs 22 mins

Basics explained: Why does the Rupee fall?

By Simplus Information Services | Y ahoo Finance India Wed 30 Oct, 2013 10:21 AM IST

The rupee has been making headlines the past few months after it dropped to its lifetime-low of 68-to-a-dollar levels. Jokes were being forwarded that the rupee has retired. The valuation of a currency is important, especially in an import-dependent country like India. It is always fixed against another currency and follows the basic demand-supply-price dynamics. Higher the demand, greater the value. In such a case, to understand the rupees fall, one needs to identify stress factors that hamper demand. Here are some: 1) Sentiment: A big part of trading is sentiment. This is nothing but investors expectation about the future prospects. A dampening of sentiment, thus, causes traders to sell and leads to a fall in the valuation. Indias economy has grown at the slowest pace in a decade. Growth in the economy has fallen from a peak of 9% to sub-5% levels. And this slowdown is expected to continue. In contrast, investors are happy with the recovery in the US economy. Hence, the preference for dollars over the rupee. 2) Speculation: Traders try to guess the rupees value over a certain period of time on the basis of various factors. This is called speculation. This is done so by betting using currency futures a derivative instrument. Speculation affects the underlying value of the rupee. 3) Current account deficit: Current account deficit (CAD) is when a countrys payments to other nations exceed the amount it receives. This is predominantly led by a huge import bill. Since the payments are in foreign currency, it means sale of rupees. Higher selling leads to a fall in value. In the last five years, Indias current account deficit has risen more than 10-fold. Related Video

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Basics explained: Why does the Rupee fall? - Yahoo India Finance

4) Fiscal deficit: Fiscal deficit is when the government spends more than it earns. This means high debt. Fiscal deficit and CAD are together called twin deficits, which the government is frantically trying to curb. While developing countries are expected to have a higher deficits, too much debt increases risks. 5) Monetary policy: The Reserve Bank of India (RBI) regularly monitors Indias monetary policy by deciding lending rates and regulating the banking sector. This indirectly affects corporates, the economic growth, and thus, the valuation of the rupee. The RBIs first priority is to tackle high inflation. For this purpose, we have had a high interest rate regime for the past few years. In contrast, the US has had near-zero rates since the 2008 crisis to fuel demand and growth. The RBI also regularly intervenes in the foreign exchange market to curb fluctuations. It sells dollars from its forex reserves. This is a temporary measure to halt the slide of the rupee by creating artificial demand. Slideshow - Most traded currencies in the world

This currency is among the worlds dominant reserve currencies and is most used in international transactions. Abbreviated as US$, United States dollar is the official currency of the United States ...
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Basics explained: Why does the Rupee fall? - Yahoo India Finance

6) Inflation: India has battled high inflation for many years. Retail inflation, measured by the CPI, has hovered in double digits. This hampers everything from individual budgets to industry and economy. For this reason, investors prefer to buy the currency of a country with lower inflation. In the US, inflation is barely 2%. Another reason for the dollar-rush. 7) Economic growth: The economy is measured by the Gross Domestic Product (GDP). A growth in GDP signifies expansion. Higher the growth, greater the value of an economy, and consequently more demand for its currency. Indias GDP growth forecast has been downgraded by analysts worldwide from over 6%-levels to 5%-levels.

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