Lowering of INR against Dollar

How exchange rates are determined?

Market forces, like demand and supply fluctuates the exchange rates within the economy. In case of US Dollar to INR, if demand of US dollar increases against INR then rate of USD against INR will also increase but there are many factors which affect market condition or market forces.

Volatile Market

When market becomes volatile investor tries to withdraw their funds from the market till the market become stable and when US investors start withdrawing their funds then the demand of dollar suddenly increases which leads to the appreciation of USD.

Speculative Activities

Once the market becomes volatile it starts influencing the exchange rate then speculative investors indulge in buying and selling of currencies which again effects demand and supply of currencies

Fiscal Deficit

Fiscal deficit makes government to finance shortage of funds from institutions like World Bank which again affect the demand and supply of currency and fluctuates exchange rates.

Interest Rates

In developing countries like India interest rates is higher as compared to developed countries like US which attracts foreign investor to invest in Government bond with an aim to mitigate their foreign market losses as well as minimizing risk factor. As a result, it again affects demand and supply of money and fluctuates exchange rates.

Imports and Exports

It is a major factor which influence exchange rate. If the imports of India are more than its exports then demand of dollar will increase and result into depreciation of Rupee.

Open market operations

RBI has the authority to intervene into the market on behalf of government to control the volatility of Rupee Dollar rate by buying and selling dollars as per the situation in the market.

Current Scenario

The rupee is lowering against Dollar at present. The reason behind is not only demonetization but also outflow of foreign investors’ money from the equity as well as bonds. According to the reports $5 billion of outflow was recorded on 29th November by Foreign Institutional Investor in local equity and bond market. This outflow results into increase in demand of dollars and depreciates the rupee.

There are three reasons which have contributed to the depreciation of currency.

Demonetization

Due to demonetization country’s GDP will going to be adversely affected by the end of this quarter and may even affect for a longer period.

Due to demonetization exports are facing hard time to meet the order deadline which will again affect countries export and decrease the flow of dollar.

Trumps Victory

With the winning of Donald Trump the foreign investor is expecting a rise in US interest rate as well as implementation of reflationary policy which results into monetary tightening.

Foreign investor invests in India due to higher interest rate as compared to US interest rate. They prefer in investing bonds in India which is a safer mode of investment as well as higher return on investment for them.

If interest rate does increase in US then there are chances that huge amount of money will flow out of India which in turn will end up in US equity markets and bond markets.

Effect on equity and Bond market 

Depreciation of rupee has resulted into shrinking of foreign investor portfolio because foreign investor invested in rupee denominated bond and equity. Investors pulled out fund from the market as they were getting fewer dollar.

References

http://www.thehindubusinessline.com/portfolio/how-rupeedollar-rates-are- determined/article4629962.ece 

https://www.bloomberg.com/news/articles/2016-11-24/rupee-falls-to-brink-of-record-low-as-india-outflows-accelerate

http://economictimes.indiatimes.com/markets/forex/rupee-drops-to-lowest-level-since-aug-2013-down-over-26-paise-at-66-82/articleshow/55593505.cms 

http://www.livemint.com/Money/qsPNucizeFRSPg8Iad6uxH/Rupee-erases-early-gains-trades-at-6855-against-US-dollar.html

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About the Author

This report has been prepared by Vivek Agarwal  and published by Apekshit Ostwal, pursuing MBA from Institute of Management, Nirma University located in Ahmedabad, India.

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