How to Fool People on Indian Rupee depreciating Against US Dollar
This blog is related to Indian Context.
There are many factors affecting USD-INR exchange rate. Let us just focus on two factors for now. Before going into the factors we should keep in mind that US Dollar is the reserve currency of the world.
Balance of Trade:
The difference between Country’s Imports and Exports is called Balance of Trade. To boost INR, we, Indians, as a country need to export more than we import so that we get Dollars into our Country. If we import more then we have to spend more Dollars to buy goods and services from other countries. Alternatively, if we export more the we get net Dollar flow into our Country. Example: We import more than 80% of the crude oil, so we need to pay Dollars to get Crude Oil, so Dollar outflows from our Country. Alternatively, we export Pharmaceutical products, so we get Dollar inflow to our Country.
Interest Rates:
Currency almost depreciates to the Interest Rate Spread. So,What is Interest Rate Spread? Let us understand this with an example. Assume that the Interest Rate of Savings Deposit in India is 6% and in US is 2%. The difference 4% (6%-2%) is called the Interest Rate Spread.
Let us understand the influence of Interest Rates with an example. Assume 1 US Dollar = 100 Indian Rupees on 01 Jan 2020. Let A lives in US and deposits 1 US Dollar in bank and B lives in India and deposits 100 Rupees in bank. The interest rate is 2% in US and 6% in India. So, after 1 year i.e., on 01 Jan 2021, A has 1.02 Dollars in his bank and B has 106 Rupees in his account. If we assume 1 USD = 100 INR on 01 Jan 2021, and A tries to convert his 1.02 Dollars into Indian Rupees, then he will get 102 Indian Rupees (as 1 USD = 100 INR). So, by depositing in US, A lost 4 Indian Rupees. Seeing this loss, A tries to convert his Dollars into INR and deposits in Indian banks. If this happens on huge scale then US banks will run out of Dollars as everyone will deposit money in Indian banks.
If the INR depreciates by the interest rate spread of 4%, the on 01 Jan 2021, 1USD = 104 INR, so if A tries to convert his currency into INR then he will get 106.08 Rupees (1.02 Dollars x 104 INR/USD).
To stop INR from depreciating, we should keep interest rates lower than US. If the interest rates are decreased people go on strike like this and opposition slams the Government like this.
So, we, the Politicians/Intellectuals/Economists/Media, talk on both sides of the debate and fool the people.
There are many other complex factors involved in currency depreciation. This blog is written just to explain things in layman terms.
