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Deep Dive Into Cryptocurrency. ET Markets Conclave — Cryptocurrency. Reshape Tomorrow Tomorrow is different. Let's reshape it today. Corning Gorilla Glass TougherTogether. ET India Inc. ET Engage. ET Secure IT. In the foreign exchange market, most of the world's currencies are bought and sold based on exchange rates. The value of the exchange rates fluctuates depending on the supply and demand of the currencies in the foreign exchange market. Monetary Policy.
Monetary policy is a powerful tool used by the central banks to control the supply and demand of the currency and thus influencing the exchange rate. One of the ways the RBI controls the movement of the rupee is by changing the interest rates. For example, When RBI allowed the banks to increase interest rates on Non-Resident Indians NRI rupee accounts and brought them on par with the domestic term deposit rates, the inflow of funds from NRIs went up, which raised the demand for rupees and ultimately led to the appreciation of the currency.
Similarly, depreciation of the rupee is caused by the decrease in interest rates. RBI also buys and sells US dollars in the open market to control the value of the currency.
Some other ways through which RBI control the availability of money in circulation, thus impacting the value of the currency is by regulating the following:. Inflation also impacts the value of a currency. When there is too much supply of money but no economic growth, prices of goods and services inflate. The central bank can counteract the situation by increasing the interest rate of borrowing money. High-interest rates discourage people to spend money. Instead, it encourages them to save money.
Inflation essentially is a measure of the degree of economic stability. A low and stable inflation rate is desirable for attracting foreign investment. Rupee depreciated against the USD from This happened despite RBI's effort to stabilize the value of the rupee by selling US dollars from its foreign exchange reserves. A country with stable economic conditions and political situations generally has a higher exchange rate because it is in high demand in the currency market as investors are confident with their investments.
Key economic indicators like the gross domestic product GDP , unemployment rate, trade balance, inflation rates, interest rates determine the value of the currency exchange rates. Political tensions can also negatively impact the value of the currency. As the demand decreases, the rupee will depreciate. Various factors cause the volatile nature of the Indian currency.
The value of INR is significantly affected by crude oil prices as India imports a large quantity of it. An increase in oil prices causes the value of the Indian currency to drop.
As we discussed earlier, a fall in foreign investments in the Indian market, interest rates, inflation in the country also contribute to the depreciation of the INR.
Devaluation of the currency makes imported goods expensive, foreign travel and fees for studying abroad become costly. They exist as entries in ledgers of financial intermediaries and can be used to make payments for goods and services.
One rupee in is not the same as one rupee today, both in terms of appearance and purchasing power. The value of a currency depends on factors that affect the economy such as trade, inflation, employment, interest rates, growth rate and geopolitical conditions.
Latest Must Read Markets. Economy Corporate Markets. Infra Pharma Real Estate. Stocks Auto World. Education Jobs Lifestyle. We also see that net spot market intervention was the lowest during the third regime and in the direction of net USD sales, whereas the higher forex interventions in the first, second, and fourth regimes were mostly in the direction of dollar purchases. Since the EMP by construction can be managed either through forex intervention or by letting the currency fluctuate, if we plotted the nominal INR--USD exchange rate instead of the net forex intervention in Figure 2, we would get an exact mirror image of the blue line in the graph.
In other words, in three out of the four regimes, the INR faced an appreciation pressure and the RBI intervened in the forex market to buy USD and reduce the extent of appreciation. In only one regime when INR faced a depreciation pressure , the RBI intervened relatively less in the forex market and did not sell a significant amount of USD from its forex reserves. During this period the exchange rate was predominantly in a floating regime, which truly responds to the market forces.
For majority of the time period examined, the RBI has been a net buyer of USD in response to an appreciation pressure on INR, as seen from the density of the scatterplot in the lower right-hand quadrant of the graph. This further suggests that the RBI does not intervene in the forex market only to contain volatility of INR because if that had indeed been the case, then there would have been a more well-rounded distribution of the scatterplot.
Using data-driven analysis, we find that INR has not consistently followed a market-determined exchange rate for most of the period between and This was the period from to in the aftermath of the GFC when the INR faced a pressure to depreciate and the RBI, instead of selling USD from its forex reserves to arrest the rupee movement, allowed the currency to depreciate.
In all the other regimes, the RBI mostly bought USD in the forex market, thereby accumulating a large amount of reserves, with the attempt being to prevent INR from appreciating.
We find that when INR faces depreciation pressure, the RBI uses only a tiny fraction of reserves to defend the currency — the RBI is much more proactive in its currency management when INR faces pressure to appreciate. I4I is now on Telegram. Please click here Ideas4India to subscribe to our channel for quick updates on our content. Understanding the dynamics of the rupee-dollar exchange rate.
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