So recently, the Rupee surged to a two year high of 63.60 against the US Dollar before closing in at 63.70.
But do you ever wonder why the US Dollar (USD) is a more superior currency than the Indian Rupee (INR)?
Why is the value of an Indian Rupee not equal to the value of a US Dollar?
How is the exact value of a Rupee against a Dollar?
Don’t you worry, don’t you worry now…we have an answer for you!
You see, currency, like equities, bonds, securities and other financial instruments is floated in the markets in the form of Forex Trading. So, as per free market logic, the value of a currency increases or decreases as per the demand for that particular currency.
But currency in any form is always in demand, right? How does the demand increase or decrease?
Well, there are a number of factors that affect the demand of a currency like
1. The FDI and FII in the country
Let’s say you wish to do business in a particular country because of the cheap resources it offers and the kind of demand your product or service has there. So, in order to invest, you would have to trade the currency used in your country for the currency that is accepted in that country. This, in economic terms means that the demand of the currency for that country is increasing as compared to the demand for the currency of your country. This concept of a global player investing in another country in the form of land or manpower in order to conduct business is called FDI- Foreign Direct Investment.
FII or Foreign Institutional Investment on the other hand is when a global player invests in liquid property like stocks, bonds or other financial instruments that a particular country offers. Generally, FDI is preferred more since FII can be liquidated anytime and can cause panic in the market.
2. Imports and Exports
Simply stated, if you want to import something, you must buy it in the currency that the selling party accepts. When you export something, the buying party has to trade their currency for the currency that is accepted in your country in order to pay you. So, the more you import the more you devalue your own currency and the more you export, the more demand your currency generates. That’s exactly why importing mineral oil has heavy restrictions to ensure that all our foreign exchange isn’t blown away in just one commodity.
3. Speculative Trading
When people start buying or offloading a certain currency in large volumes, the market goes into a frenzy and what follows is the herd effect where everyone cashes in on the trend. This acts as a strong force for determination of currency valuation.
4. Monetary Policy
Every country generally has a central bank like we have RBI in India and Federal Reserve in the USA which lays down guidelines and policies which affects the currency valuation.
5. Other Factors
A variety of other economic and demographic factors may affect the currency valuation. One example of this could be the salary of expats who get paid in rupees but may exchange it for their native currency thus devaluing the Rupee further.