Causes of Rupee Appreciation & Depreciation
Rakesh Lahori
But do we really understand what could be the possible causes for a nation’s currency to either appreciate or depreciate???
Before we jump to the causes, let us first understand what we mean by currency appreciation or depreciation.
Rupee depreciation means that rupee has become less valuable with respect to dollar. If the rupee moves from Rs. 50 per dollar to Rs. 60 per dollar then the rupee is said to depreciate. It means that the rupee is now weaker or cheaper than what it used to be earlier. While one dollar was available for Rs. 50 earlier, the same is now available for Rs. 60.
Similarly, Rupee appreciation means that the rupee has become more valuable or stronger with respect to the dollar. If the rupee moves from Rs. 60 per dollar to Rs. 50 per dollar then the rupee is said to have appreciated. It means that the rupee can buy more dollars than earlier.
This is vital because when we import goods, we have to first buy the dollars and then the goods. So if dollars are expensive, it follows that imports are expensive.
Hope the concept of rupee appreciation or deprecation is made clear by the above explanation.
Currency price like any commodity is also determined by demand and supply of that currency in the international market.
When supply of rupee increases, value of the rupee falls. The opposite holds true when demand for rupee increases.
Now let us understand the factors that can cause Rupee appreciation or depreciation.
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Current Account Deficit is when a country’s imports are higher than its exports. When a country imports more, it needs to pay in foreign currency, causing the country’s currency to depreciate as demand for the foreign currency increases. The opposite holds true in case of Current Account Surplus. |
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Capital Account Flows: Current Account Deficit is funded by capital flows and current account surplus generates capital outflows (investment in foreign countries). When there is capital inflows in India, demand for rupees increases leading to rupee appreciation. Capital outflow causes the rupee to depreciate because money moves out as dollars and hence the demand for dollars goes up causing rupee depreciation. |
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Interest Rate: A country with high interest rates attracts foreign investors because interest rates in their country are less. Thus demand for the rupee increases, resulting in appreciation in the value. However this arbitrage benefit that is sought by investors is dependent on the stability of the currency. Else the returns due to incremental interest rates would get offset by currency depreciation. |
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Inflation: High inflation impacts the country’s exports as goods become expensive for other countries resulting in decreased demand for the rupee leading to depreciated rupee value. |
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Income Changes: When employment and per capita income in a country increases then increased domestic income is associated with an increased consumption of imported goods. As consumers purchase more imported goods, the demand for dollars will exceed its supply and dollar will appreciate. |
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Monetary Policy - Countries with easy monetary policies can increase the supply of their currencies, which will cause the currency to depreciate. If a nation’s central bank is pursuing an expansionary monetary policy its currency is likely to weaken. |
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Hope you have understood the factors that cause Rupee appreciation or depreciation. |
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Sumeet Kohli
good info Rakesh...
