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Table of Contents........................................................................................................1 Devaluation of Rupee..................................................................................................1 Introduction.................................................................................................................2 Meaning of devaluation of Rupee................................................................................2 How currency value is determined?.............................................................................3 Major Factors Influencing the Currency Value..............................................................4 4.1 Inflation..............................................................................................................4 4.3 Current Account Deficits.....................................................................................5 4.4 Dollar is in Demand............................................................................................5 4.12 Transaction demand for money .......................................................................8 4.13 Speculative demand of the currency...............................................................8 Why any country would want to keep its currency value low?.....................................9 Why RBI intervene on Currency valuation?.................................................................9 Impact of currency devaluation/ Weakening Rupee: Good for NRIs, Bad for Indian Economy................................................................................................................10 Rupee depreciation benefits some but not good for the Indian economy...................11 8.5 Increase the burden of servicing and repaying of foreign debt of the Indian Government (which has dollar denominated debt) and those companies that have raised dollar denominated debt..............................................................................13 8.7 Higher interest rates........................................................................................13
Devaluation of Rupee
Introduction
The past few months have been disastrous for the rupee value against dollar currency.Rupees value hit a terrible low on 13 December 2011 against the Dollar, falling to an alarming Rs. 53.22 per dollar. It has depreciated about 17% from the early August levels ($1 cost Rs. 44.0749 per Dollar on 1st August 2011). This kind of devaluation would have drastic impact on the macro economy of the country like heavy raise in the import cost where countries like India heavily depends on the importing on Oil and other crucial raw materials needs for the industries.
There are many factors to decide the currencies values but that could be very difficult for the common man to understand the theory. In the simple words it is explained why the currency value is often fluctuated. A currency will tend to become more valuable when its demand is higher than supply. A currency will tend to become less valuable when its demand is less than supply. It is the basic theory. We need to understand in the global economy terms, when the currency will have more demand and when it will have less demand.
In a nutshell, we can say that Currency follows the concept of demand and supply. Depreciation is caused when the supply of the currency circulated in the economy is more than the demand for that currency. Likewise if the supply of the currency is less than its demand, the value of the currency increases or appreciates. In today's world, most currencies 'float'. The exchange rate between any two currencies fluctuates from day to day and throughout the day. The exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. . Exchange rates for such currencies are
likely to change almost constantly on financial markets, mainly by banks, around the world. Therefore, we can say that, exchange rates are expressed as a comparison of two currencies. It is always relative and can be measured between two countries. Is the currency backed by gold or not? The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold and all currency issuance is to one degree or another regulated by the gold supply. To protect the public and guarantee the nation against any bankruptcy, the RBI keeps a certain percentage of gold in their own safe deposit vault, in proportion to the additional currency minted and directed into the circulation. The quantum percentage of gold kept in the deposit is not exposed in any documents or in the Websites of RBI or the Government of India. In what conditions RBI would print currency? RBI would print currency in 2 conditions. Firstly, when the notes are mutilated or soiled it would print the currency. Secondly, when it wants to increase liquidity in the market/economy. RBI would initially lessen the interest rates so that liquidity in the market increases but even then if the situation is not controlled then RBI will use its cash reserves and would want to inject them in the market to increase the liquidity. Now, RBI will buy bonds from banks using its cash reserves and thus will be injecting more money / liquidity into the market. Even then if there is a need for RBI to print more currency then it has to maintain gold or forex reserve in proportion to the amount of printing money. If they have sufficient reserves its fine or else it has to borrow gold or forex from World Bank. Now, this loan from World Bank will be shown as deficit in our Balance of Payment since it needs to be paid back.
4.1 Inflation
As a general rule, 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 in relation to the currencies of their trading partners.
demand for that currency. Likewise if the supply of the currency is less than its demand, the value of the currency increases or appreciates. BRIC countries like India have emerging economy, so a huge percentage of investment in India is from outside the country, especially from US but due to recession in US, big institutions are collapsing and many of them are on the verge of breakdown. They are suffering huge losses in their country. They have to maintain their balance sheets and look strong on all statements, so to recover losses in their country, they are pulling out their investments from India. Due to this pulling out of investment by these big companies from India or in other terms disinvestment, demand of dollar is raising up and rupee is depreciating. Heavy dollar demand from importers and oil refiners is one of the reasons why rupee is depreciating. The crude oil prices are increasing which are in turn appreciating dollar as demand for dollar is increasing
external debt outstanding as of June-2011 was $317 billion, an increase of 38 per cent in last two years. The short-term external debt increased at a much faster pace of 62 per cent (in absolute terms) during the same period and it now constitutes about 21.6 per cent of total external debt. One worrying factor is that much of the debt is maturing in next one year. Due to re-capitalisation needs of European banks, it is likely that these banks will be less forthcoming in refinancing Indian corporate debt. All this is pushing pressure on rupee and has increased demand for dollar which is depreciating rupee.
Speculation may also play a part in influencing exchange rates especially of smaller economies where buying or selling huge volumes of the currency can have a marked if temporary impact on the exchange.
Why any country would want to keep its currency value low?
Some economists argue that a country will intentionally keep the exchange rate low so that buyers on the world market will not purchase the Yen for example. You would think that a weak national currency would indicate that this country is poor. Not always the case (China is a good example), the argument is that nations like Japan and China want their currency to be low in value so that other nations (like the US) will buy more Japanese and Chinese products imported. Think about it, if the US dollar is twice as strong as the Yen, than it can buy twice as many Japanese goods. If a computer costs 1,000 dollars in the US, but 1000 Yen in Japan, than you could buy two Japanese computers.
Fiat Currency
All modern monetary systems are based on the principle of fiat currency. This means that the value of money is derived not from any intrinsic value (as if it were made from precious metals) or the promise to redeem them for a set amount of precious metals but because the government dictates that it must be accepted as currency. The value of money is set by a mixture of what the government says it should be and what private and public speculators say it should be.
The Government
The government issuing flat currency takes the primary responsibility in setting its value. When a government prints fiat money, it is acting as a creditor in the sense that it promises the money is worth something. If a government does not back the value of its currency through an appropriate level of taxation, the money loses value. This is why budget deficits, national debts and central bank interest rates have an impact on what a currency is worth. Strong backing on the part of the public, strong economic performance and a healthy private banking sector can all mitigate this, however.
The Market
In the modern world economy, currency itself is treated as an investment commodity. The result is a speculative market where investors migrate between currencies seeking the convert capital into the best haven for their investment. This can cause a nasty feedback loop. A government with a weak economy, weak banking system or high budget deficits (or any of the above factors) will see the value of its currency erode visa-vis other currencies. This will cause money speculators to bet against it, driving it further down. The example of the sharp decline in the value of the dollar in 2007 and 2008 were good examples. Market speculation compounded the triple problems of weak economic performance, banking sector scandals and high budget deficits to produce a worldwide crisis in confidence against the U.S. dollar, driving it to records lows against most other major world currencies. This reflected the flight of private investors and foreign treasuries away from the dollar as the currency of choice
Impact of currency devaluation/ Weakening Rupee: Good for NRIs, Bad for Indian Economy 7.1 Good news for NRIs
The rupee is falling. And it is good news, as usual, for the NRIs, who are in the habit of remitting money to India. This works well for the salaried class who can now send more money to their loved ones in India for the same dollar amount. With India receiving the highest remittance in the world ($55 billion in 2010), a fall in rupee can actually benefit the whole NRI population. This means that a NRI who remitted $1000 to her family in India in early August was able to send only around Rs. 44,100. But if she sends the $1000 three months later, when the rupee depreciated to Rs. 52, her family will receive Rs. 52000.
A depreciation of the Indian rupee would lead to a shift in at least a part of this competitive advantage to the Indian export firms, thus boosting Indian exports. The rise in exports will give a boost to the recovery of economic growth.
Therefore, a weaker domestic currency would make imports dearer. This will act as a barrier against imports, thus improving the trade balance.
However, imports of commodities, like oil, whose demand is relatively in-elastic could dilute, fully or partially, the likely improvement in the trade scenario. Although capital imports are needed for economic growth, the need to curb the deficits is more pressing because deficits have an inflationary impact and they can also lead to financial vulnerability.
Rupee depreciation benefits some but not good for the Indian economy.
8.1 Rising prices of imports
Depreciating rupee raises the price of imports. Many companies depend on imported material for their production like automobiles, FMCG, tyres, and etc. The producers pass this on to the consumers. This will in turn push up the inflation rate, which is
already high at 9.73%(October 2011 prices). Prices of cars, electronics, mobiles and computers will increase if the fall in rupee continues.
prices
Despite availability of cheaper raw materials, prices increased twice in two weeks. Despite crude oil and naphtha prices ruling moderate to low, petrochemical manufacturers have raised prices of polymer products twice in the last two weeks, to offset the impact of a depreciating rupee. Normally, price revision is a fortnightly or a monthly event. Officials in petrochemical companies said even if naphtha, a derivative of crude oil and a basic raw material for petrochemicals, is ruling lower at $850-860 a tonne, as against $1,000 a tonne a few weeks before, the import cost is too high. In barely two-three weeks, the exchange rate to the dollar has fallen to 53 from a stable 45-46.
8.5 Increase the burden of servicing and repaying of foreign debt of the Indian Government (which has dollar denominated debt) and those companies that have raised dollar denominated debt.
However, a major drawback of depreciation in the value of the rupee is that it will increase the burden of servicing and repaying of foreign debt of the Indian Government (which has dollar denominated debt) and those companies that have raised dollar denominated debt. This drawback is all the more amplified in the case of short-term debt as the burden is immediately felt.
Depreciating currency might dissuade foreign institutional investment (FII) from investing in the country
Another drawback of a weak currency is that it might dissuade foreign institutional investment (FII) from investing in the country. The prospects of a weaker currency could also lead to a rush for repatriation of funds by FIIs. The FIIs are permitted to transfer money in and out of the country at will and therefore if there were a legitimate fear of a large fall in the value of currency, they may be tempted to repatriate a part of their funds. This could result in a selloff in the capital markets.
achieved at the cost of a higher call money rate of over 9%. Sustained absorption of liquidity could sooner or later reflect in higher interest costs for borrowers, which could in turn adversely affect the growth in investments and consumption. There are many costs and benefits attached to a stronger and a weaker currency. However, while deciding on a policy, the economic and political situation must also be factored in. In light of the current depreciation of the rupee, one must assign a weightage to the various costs and benefits and then decide whether the depreciation is desirable or not. It is most likely that there will be large support for both views.
Why RBI is not intervening? According to Press Trust of India / New Delhi November 28, 2011, 19:46 IST Global ratings agency Moody's today said the Reserve Bank of India's (RBI) limited intervention in the currency market to stymie rupee depreciation is "positive" for the country's credit outlook. Rupee, which has slumped about 15% against the US dollar in the past three months, touched an all-time low of 52.73 against the greenback on November 22. The steep fall is hurting importers as well as entities who have borrowed in foreign currency. Noting that RBI has limited its "intervention in currency markets to periods of extreme volatility", Moody's said such restraint is credit positive. The decision not to spend large amount of international reserves to support a higher rupee is credit positive for two reasons, it said. "First, intervention would have expended reserves without reversing the depreciation effectively, since global risk aversion and India's widening current account deficit would have forced the rupee to fall further against the dollar despite the intervention," Moody's Investors Service said in a report. Further, it pointed out that effective globalization requires market participants to adjust their investment, consumption and borrowing plans as per the availability of foreign capital and import costs. India's foreign exchange reserves stood at nearly $309 billion as on November 18, as per official data. "Had authorities used official reserves to maintain the exchange rate at a level higher than dictated by market forces, they would have assisted importers and foreign borrowers at the expense of exporters and import-competing
domestic producers," Moody's noted. Such a move would have delayed or distorted private sector adjustment to global market signals. "We expect that currency depreciation, by making imports more expensive and exports cheaper, will ultimately force an adjustment, and help narrow the current account deficit over the next few quarters," the report said. On the other hand, sliding rupee also widens the country's already high fiscal deficit, as the scenario raises the government's petroleum products related subsidy burden. The rupee depreciation could also result in higher inflation, which is hovering over 9%, Moody's said. Earlier in the day, Prime Minister's advisory panel chief C Rangarajan said movement in global commodity prices, and not the declining value of rupee against dollar, would have bigger implications for the inflation. The Central Bank of any country is entrusted with the responsibility of protecting the value of its home currency. They usually kick into action when they suspect any speculative attack on their currency by external forces (Intentional attempts to devalue a countrys currency) In this case, the devaluation of the Indian Rupee was not due to some intentional attempt by anyone. It was due to the global economic scenario and any steps they take might backfire if the global economic situation worsens. The RBI just let the economy take its course with the exchange rate between US Dollar and Indian Rupee because there was no foul play suspected. A point to note here is that, the RBI is closely monitoring the situation and may intervene if they feel the depreciation is too much.
In fact most of the educated population in any country, use the local currency without knowing the background and validity of the same. I am happy that you have asked this question, which will impart a mandatory knowledge to many people all over the world. Because what is in India is applicable to all over the world. A) What and who decides the money (currency) in circulation in Indian money market ? a) The Reserve Bank of India (RBI) manages currency in India. The Government, on the advice of the Reserve Bank, decides on the various denominations. The Reserve Bank also co-ordinates with the Government in the designing of bank notes, including the security features. The Reserve Bank estimates the quantity of notes that are likely to be needed denomination-wise, and places the indent with the various presses through the Government of India. The notes received from the presses are issued and a reserve stock maintained. Notes received from banks and currency chests are examined. Notes fit for circulation are reissued and the others (soiled and mutilated) are destroyed so as to maintain the quality of notes in circulation. The Reserve Bank derives its role in currency management on the basis of the Reserve Bank of India Act, 1934. b) To facilitate the distribution of notes and rupee coins, the Reserve Bank has authorised selected branches of banks to establish currency chests. These are actually storehouses where bank notes and rupee coins are stocked on behalf of the Reserve Bank. At present, there are over 4368 currency chests. The currency chest branches are expected to distribute notes and rupee coins to other bank branches in their area of operation.
B) Can reserve bank of India or Indian government bodies decide to print additional currencies to meet public expenditure ? a) The Reserve Bank estimates the demand for bank notes on the basis of the growth rate of the economy, the replacement demand and reserve requirements by using statistical models. The Reserve Bank decides upon the volume and value of bank notes to be printed. The quantum of bank notes that needs to be printed broadly depends on the annual increase in bank notes required for circulation purposes, replacement of soiled notes and reserve requirements. b) The Government of India decides upon the quantity of coins to be minted. The responsibility for coinage vests with Government of India on the basis of the Coinage Act, 1906 as amended from time to time. The designing and minting of coins in various denominations is also attended to by the Government of India C) Do India need to Deposit some gold in IMF for additional currency printing for meeting the public expenditure. a) No. Absolutely there is no external foreign or IMF control on the estimation, printing or circulation of Indian rupee notes and coins. But the only external control on the value of Indian money in the international circulation is the Exchange rate, with reference to various other national currencies. Indian money is tied to a basket of European currencies (now jointly represented by Euro). The exchange rate parity of rupee fluctuates based on the Indian balance of payment to the world, exports/imports and the parity of Euro in the international market. b) The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold and all currency issuance is to one degree or another regulated by the gold supply. To protect the public and guarantee the nation against any bankruptcy, the RBI keeps a certain percentage of gold in their own safe deposit vault, in proportion to the additional currency minted and directed into the circulation. The quantum percentage of gold kept in the deposit is not exposed in any documents or in the Websites of RBI or the Government of India.. c) In modern mainstream economic thought, a gold standard is considered undesirable because it is associated with the collapse of the world economy in the late 1920's. That aggregated the need for the supply and demand in a far better means of regulating interest rates, money supply and monetary basis. However, many other theories have been advanced for the turbulent economic conditions that existed at this time. While the gold standard is not currently in use, it has advocates for its resurrection and forms part of a basic theory of monetary policy as a standard for comparison for other monetary systems. Advocates of a variety of gold standards argue that gold is the only universal measure of value, that gold standards prevent inflation by preventing the creation of unlimited money supply in a fiat currency, and that it provides the soundest theoretical basis for a monetary system. d) In todays economics the fiat currency (a legally binding command or decision entered on the court or government record ) or fiat money is money that enjoys legal tender status derived from a declaratory fiat or an authoritative order of the government. It is often associated with paper money because, without government fiat, bank notes are not a legal tender in payment of debt, and only specie (metal money) has unlimited legal tender for money debts. (Note : This is not universally true, as some currencies, notably sterling issued by Scottish banks, is not legal tender but is accepted by longstanding confidence in the Scottish banking system). e) A Fiat currency or coin is guaranteed by the RBI and the Government of India that :A unit of paper or credit money (a rupee) can be presented to the issuing bank in exchange for a physical amount of gold, silver, or some other commodity. A rupee can be returned to the issuing bank in exchange for a rupee worth of the banks assets. To enable this guarantee, the RBI and the Government of India create adequate assets in the nation with assured value, equal or more than the additional notes and coins minted and sent in circulation. This is in addition to the percentage of gold kept in the safe deposit vault of the RBI (See C-b above). d) The term fiat currency is also used specifically to refer to a currency that is not pegged or fixed to a mass of precious metal, and similarly the term gold standard is used to refer to fiat currency with a gold bullion exchange system, or to a parallel gold coin/fiat currency with a law that requires that the fiat currency bank of issue to pay in gold coin.
e) The fiat currency is explicitly circulated in the form of paper money. The inherent value of paper money is zero, except when it is measured against the value of consumables the bearer of such worthless paper can exchange for each unit of currency in his or her possession. Additionally; paper money has an intangible value that is directly related to the condition of need of its bearer. While a one hundred rupee currency may be inconsequential to a person with little material need the same may be the governing factor between homelessness, health, and even life for another with lesser means.. In other words, paper money is valued at the maximum amount of consumable for which it can be traded either directly or indirectly. D) If yes, Is there any external power controlling the Indian money market or world money market who decide how much & how India should make currency in circulation. The answer is NO. Please see answer ( C ) above. E) Additional reference and informative reading materials a) Reserve Bank of India : Frequently Asked Questions - Your Guide to Money Matters. http://www.rbi.org.in/scripts/BS_CurrencyFAQView.aspx?Id=39 http://www.rbi.org.in/scripts/AboutusDisplay.aspx
Mostly the higher the interest rate of one country, as compared to another causes the higher value on the currency. Higher rates of interest equals higher value of currency. Increase the interest rates in America versus the rest of the world, and then you have higher dollar values.
Interest rates are a huge factor. If interest rates rise, the country's currency is worth more because it becomes more attractive to put money in that country. Think about it this way, if bank A gives you a higher interest rate
on your savings account than bank B, wouldn't you want to move your money over to bank A? The same goes for countries. As interest rates decline, the currency usually declines as well. Other economic factors also can affect a currency's value. If the economy is doing well and people expect it to continue to do well, the currency will rise. If the country is doing poorly, the currency will fall. Buying currency is similar to buying stock. You want to own something that you believe will become better, not worse.