What determines exchange value of currency – rubble case study
What determines exchange value of currency – rubble case study
Subject: Economy
Section: External Sector
Context:
The Russian ruble has staged an impressive recovery after it lost about half of its value in the wake of Russia’s invasion of Ukraine.
Concept:
The currency has recovered almost all of the losses it incurred following the invasion and has thus, surprised many who had predicted a further fall in its value.
Cause:
- Capital controls that aim to increase demand for roubles and reduce the demand for dollars. For example, the Bank of Russia ordered Russian energy exporters, who still had access to US dollars, to use 80% of their forex holdings to purchase roubles.
- The Russian central bank, also ordered Russian brokers to not allow foreigners to sell their assets in Russia to prevent the outflow of capital which would further depreciate the rouble as investors sell their roubles to purchase dollars.
- The Russian central bank’s decision to raise its benchmark interest rate to 20% could have also helped draw some foreign investment that propped up the exchange value of the rouble.
- Lastly, peace talks between Russia and Ukraine have also perhaps helped in the rouble’s recovery to some extent by raising hopes of a return to economic normalcy.
Determination of exchange rate:
The price or exchange value of any currency is determined by the supply and demand for the currency.
Rouble depreciation post Ukraine crisis was mainly due to the decline in supply of the US$ relative to the Russian rouble thus, leading to the depreciation in the currency.
Causes of decline in supply of the US$
- When Western governments imposed sanctions, it made it harder for dollars to flow into Russia in terms of investment or financing for Russian exports
- Sanctions on the Russian central bank also made sure that the Bank of Russia could not flood the currency market with US dollars to prop up the value of the rouble.
- Large scale capital outflows
- Russian banks banned from SWIFT delayed payment settlement.
- The demand for foreign goods and assets, however, remained stable and when and when combined with a drop in the inflow of dollars, it caused the value of the rouble to fall
| Exchange Rate Systems The three major types of exchange rate systems are the float, the fixed rate, and the pegged float.
Currencies with floating exchange rates can be traded without any restrictions, unlike currencies with fixed exchange rates. Flexible exchange rate mechanism can be explained below where DD and SS are demand and supply curves. When Indians buy US goods, there arises supply of dollars and when US people buy Indian goods there occurs demand for rupee. Initial exchange rate—Rs. 40 = $1—is determined by the intersection of DD and SS curves in both the Figs. 5.8(a) and 5.8(b). An increase in demand for India’s exportables means an increase in the demand for Indian rupee. Consequently, the demand curve shifts to DD1 and the new exchange rate rises to Rs. 50 = $1. At this new exchange rate, the dollar appreciates while the rupee depreciates in value [Fig. 5.8(a)]. Fig. 5.8(b) shows that the initial exchange rate is Rs. 40 = $1. Supply curve shifts to SS1 in response to an increase in demand for US goods. SS1 curve intersects the demand curve DD at point B and exchange rate drops to Rs. 30 = $1. This means that the dollar depreciates while the Indian rupee appreciates.
To ensure that a currency will maintain its “pegged” value, the country’s central bank maintains reserves of foreign currencies and gold. They can sell these reserves in order to intervene in the foreign exchange market to make up excess demand or take up excess supply of the country’s currency. The most famous fixed rate system is the gold standard, where a unit of currency is pegged to a specific measure of gold. Regimes also peg to other currencies. These countries can either choose a single currency to peg to, or a “basket” consists of the currencies of the country’s major trading partners.
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