Why a strong rupee is good

Why a strong rupee is good

Subject: Economy

Context:

India has moved to the fifth largest economy in dollar terms, despite the rupee depreciation.

Details:

India’s trade deficit is perennially negative and therefore the rupee will be weak

What if the rupee appreciates—What if the rupee was trading at ₹60 to the dollar and not at ₹80+?

• The reduction in the import bill of oil.
• Fall in fuel price-If the price benefit is passed on to the consumer it will cause reduction in the price of fuel.
• Fall in inflation-The high fuel cost has a cascading inflationary effect on the entire economy, and that can be moderated.
• Rise in the purchasing power of money-due to fall in inflation, saved money can be used in the consumption of other goods.
• Reduction in exports.
• Capital inflows-If the rupee is expected to strengthen, then immediately dollars start to flow into the country fast as no one wants to lose with lower exchange rates at a future date.
  • Note- Here expected appreciation in the future will cause capital inflows in the present. However, a current appreciation will cause capital outflows as no one wants to lose with lower exchange rates if rupee appreciates.

Concept:

• Currency appreciation refers to the increase in value of one currency relative to another in the forex markets.
• The value of a currency is not measured in absolute terms. It is always measured relative to the currency being measured against it.
• Appreciation is directly linked to demand and supply. 
  • If the value appreciates (or goes up), demand for the currency also rises or supply falls.
• Effects of Currency Appreciation
  • Export costs rise– If the Indian rupee appreciates to the US $, foreigners will find Indian goods more expensive because they have to spend more for those goods in the US $. That means that with the higher price, the number of Indian goods being exported will likely drop. This eventually leads to a reduction in gross domestic product (GDP).
  • Cheaper imports-If Indian goods become more expensive on the foreign market, foreign goods or imports will become cheaper in India. That translates to a benefit of lower prices, leading to lower overall inflation due to lower imported inflation.
  • Rise in current account deficit- as import rises and export falls.
  • Monetary policy– It is possible that an appreciation in the exchange rate may make the Central Bank more willing to cut interest rates.
    • An appreciation reduces inflationary pressure so interest rates can be lower.

The relationship between balance of payments and exchange rates under a floating-rate exchange system will be driven by the supply and demand for the country’s currency and all transactions taking place with other countries.

• Suppose there is surplus in the balance of payments-It means money inflows are greater than the money outflows due to the net positive international transactions leading to appreciation of domestic currency.
• Example-Let initial exchange rate be Rs. 40 = $1. An increase in demand for India’s exportables means an increase in the demand for Indian rupee relative to the demand of the US$ and decrease in the supply of the Indian rupee relative to the supply of the US$  . Consequently, the dollar depreci­ates while the Indian rupee appreciates.