Their exist a strong correlation in Interest rate, Inflation and Exchange rate. Central bank of any state (RBI in India) make adjustment in Interest rates to keep a check on Inflation and Exchange Rate which have impact on their respective currencies (depreciation or appreciation). The valuation of any currency is relative i.e. it is evaluated with respect to some other currency. This can be understood by the basic "Demand and Supply" principle of micro economics which says "increase or decrease in demand, will back the price in same direction" and "increase or decrease in supply will have a inverse effect on price". A currency will tend to become more valuable when its demand is higher than supply and vice versa. Or let me put it in more effective manner with an example of dollar vs Indian rupee to understand this in better fashion. Suppose there is increase in demand of dollar i.e. less supply of dollar in market, you would have to pay more Indian rupee to buy one dollar. And here paying more rupee signifies the depreciation of rupee. Similarly when supply is more than demand, rupee appreciate.
Indian economy is drifting through the challenging phase post 2011 with the very existence of recession and inflation together in economy. Measures to control one would worsen the effect of another.With already existing two evils, in recent past, we had seen the third one with the radical and extreme fluctuation in Indian rupee. From 54.76/dollar in month of June to 68.85/dollar on 28th of August, steep downside movement in rupee made the challenges even more challenging. Within a span of just three months rupee plunged down by nearly 21 percent in its valuation against US Dollar. There are many reasons like inflation, interest rate, political uncertainty and many more. Lets see what were the major reasons backing the weakening of rupee to weaken it in more acute way.
The first and the foremost ground, supported the rupee depreciation was Current Account Deficit(CAD). The current account deficit is equal to the trade balance (whether it's a surplus or deficit) + factor income (interest and dividends from international loans and investments) + cash transfers (like remittances from workers in the country to their families abroad). In simple terms CAD means incoming money is less than the outgoing money, caused a net outflow of foreign exchange means dollar's outgo, results increasing demand for dollar in Indian market, aided rupee to depreciate. Prime reason for widened current account deficit were enormous oil import and import of yellow metal (Gold) on large scale.
Another important aspect for rupee depreciation was the buzz of beginning tapering of the $85-billion per month quantitative easing (QE) that has been on since September 2012. Quantitative easing is the monetary policy used by central bank of the economy by buying financial assets from the commercial banks and private institutes to revive the falling money supply i.e. liquidating the market. The immediate impact would be on rate sensitive bond market where foreign institutional investors (FIIs) had about 30 billion dollars of investments. With the announcement of tapering by Ben Bernanke in June, there had been a massive outflow of some 10 billion dollars of FIIs from their Indian bond market between June and August which had its vast impact on Indian currency market with moving of rupee deep into the ocean.
Few measures taken by RBI and government of India to support rupee are:
1. Government has raised the import duty on Yellow and White metal to check the CAD.
2. RBI will sell Rs22,000 crore of bonds every month to regulate the volatility of forex reserve.
3. Government inked 50 billion dollar of currency swap with Japan and considering another half a dozen emerging market with which India can trade in rupee. This lessen the dollar's volatility and give boost to rupee.
4. The RBI has tightened liquidity to reduce money from the system. This increase the short term interest rates, which attract the investor to invest in India.
There were other measures as well taken by RBI to regulate dollar outflow and to boost rupee. All the steps taken by RBI or by government of India are well in place, addition to this I think government should strategies some master plan or should come up with certain proposal to improvise its manufacturing sector which is lagging behind post 70s to reduce the burden of import and flourish export.
Indian economy is drifting through the challenging phase post 2011 with the very existence of recession and inflation together in economy. Measures to control one would worsen the effect of another.With already existing two evils, in recent past, we had seen the third one with the radical and extreme fluctuation in Indian rupee. From 54.76/dollar in month of June to 68.85/dollar on 28th of August, steep downside movement in rupee made the challenges even more challenging. Within a span of just three months rupee plunged down by nearly 21 percent in its valuation against US Dollar. There are many reasons like inflation, interest rate, political uncertainty and many more. Lets see what were the major reasons backing the weakening of rupee to weaken it in more acute way.
The first and the foremost ground, supported the rupee depreciation was Current Account Deficit(CAD). The current account deficit is equal to the trade balance (whether it's a surplus or deficit) + factor income (interest and dividends from international loans and investments) + cash transfers (like remittances from workers in the country to their families abroad). In simple terms CAD means incoming money is less than the outgoing money, caused a net outflow of foreign exchange means dollar's outgo, results increasing demand for dollar in Indian market, aided rupee to depreciate. Prime reason for widened current account deficit were enormous oil import and import of yellow metal (Gold) on large scale.
Another important aspect for rupee depreciation was the buzz of beginning tapering of the $85-billion per month quantitative easing (QE) that has been on since September 2012. Quantitative easing is the monetary policy used by central bank of the economy by buying financial assets from the commercial banks and private institutes to revive the falling money supply i.e. liquidating the market. The immediate impact would be on rate sensitive bond market where foreign institutional investors (FIIs) had about 30 billion dollars of investments. With the announcement of tapering by Ben Bernanke in June, there had been a massive outflow of some 10 billion dollars of FIIs from their Indian bond market between June and August which had its vast impact on Indian currency market with moving of rupee deep into the ocean.
Few measures taken by RBI and government of India to support rupee are:
1. Government has raised the import duty on Yellow and White metal to check the CAD.
2. RBI will sell Rs22,000 crore of bonds every month to regulate the volatility of forex reserve.
3. Government inked 50 billion dollar of currency swap with Japan and considering another half a dozen emerging market with which India can trade in rupee. This lessen the dollar's volatility and give boost to rupee.
4. The RBI has tightened liquidity to reduce money from the system. This increase the short term interest rates, which attract the investor to invest in India.
There were other measures as well taken by RBI to regulate dollar outflow and to boost rupee. All the steps taken by RBI or by government of India are well in place, addition to this I think government should strategies some master plan or should come up with certain proposal to improvise its manufacturing sector which is lagging behind post 70s to reduce the burden of import and flourish export.
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