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Why does currency depreciate or appreciate?

, May 2, 2014, 1 Comments

Currency India Appreciation & Depreciation-MarketExpressThe movement in currency – rupee is linked to the Balance of Payment Account .When there is current account appreciation, as more rupee flows come to India, and also capital account surplus. Then the excess funds are used to increase Foreign Exchange Reserves by acquiring Gold, SDR ,bullion or acquiring more dollars and other currencies.

This increases the demand of dollars and appreciates their price viz a viz rupee. The reverse position occurs when there is current account deficit (when imports are greater than exports).Then, dollars are used to purchase imports. The net effect is seen of the import bill and the selling of foreign exchange reserves for rupees for analyzing the Net effect on the rupee.

In both the cases, the net effect is seen of the Export-Import bill and the buying and selling of Foreign Exchange Reserves.

There are several factors due to which the Exchange Rate appreciates or depreciates. There are several factors for the determinants of Real Effective Exchange Rate. Primarily, the difference between the productivity of GDP. The higher the productivity differential for a country viz . a viz. the other, the better is its exchange rate.

The other factor being government spending. The more the government spending done by a country, more the local currency demanded and spent, the higher its value of the currency in terms of Exchange Rate.

Also, the better the bargaining tendency in terms of  Terms of Trade for Exports and Imports prices, the more the impact on the medium term and long term exchange rate on the country’s currency.

The more the capital flows for a country in terms of Net Foreign Assets for a country, the better it can manage its exchange rate.

Another factor, which determines the Exchange Rate, is the Interest Rates Movement. The higher the Interest Rate for a nation more is the Foreign Currency flow for that nation and with the more supply of foreign currency viz.a viz the rupee, the better the exchange rate.

There has been a wide variation in the exchange Rate movement in the last 6 to 8 months. The rupee moved to 68 against the Dollar in the month of August vs. 60 now. The movements in Exchange Rates are also driven due to the net selling and buying of Dollars( Foreign Currency) between Scheduled Commercial Banks themselves besides the net buying and selling of Dollars by the Reserve Bank of India.

Also, the Currency Derivatives Trading also impacts the foreign currency movements. More the Future value of Rupee viz. a viz. the Dollar in the next 3 months if predicted against the spot price of Rupee, that will increase the Open Interest transactions in the future value of Rupee for the next 3 months in Rupee. Eventually,that acts a boost for raising the actual price of the Rupee viz.a viz the Dollar in the next subsequent months.

The movements in the Rupee Viz.a viz. Foreign Currencies has a tremendous impact on each of the citizens of the nation. The factors impacting it are therefore essential to be pondered upon.






  • P V Rajeev Sebastian

    Good article! But could have written a little more about differentials in inflation rates in different countries contributing to variation in exchange rates of currencies.