An exchange rate (also known as conversion rate) between two currencies is the rate at which one currency can be exchanged for another. Exchange rates play an important role during a country’s level of trade, which is critical to almost every free enterprise within the world today. Therefore, exchange rates are among the foremost monitored, analyzed, and governmentally controlled economic measures. Exchange rate matters not just on the large macroeconomic scene but also on a smaller one. It impacts the real return of an investor’s portfolio, the profitability of firms, growth of specific sectors amongst various other determinants of the economy.
The Indian rupee, which was linked to British Pound, was at par with the American currency at the time of Independence in 1947. There was no foreign borrowing on India’s record. In order to finance development and welfare activities, with the introduction of the Five-Year Plan in 1951, the government started to borrow externally. This required the devaluation of the rupee. After independence, India chose to adopt a hard and fast rate currency regime. USD to INR was at 4.79 between 1948 and 1966. India faced a significant balance of payment crisis in 1991 and was forced to sharply devalue its currency.
The country was within the grip of high inflation; low growth and therefore the foreign reserves weren’t even worth to satisfy three weeks of imports. Under this situation, the currency was devalued to 17.90 against a US dollar. Indian Rupee has depreciated by a little more than 74 times against the greenback in the past 73 years. On July 22, 2020, USD to INR had gone down to 74.84 and is expected to fall further. This volatility became severe within the past few years affecting major macro-economic data, including growth, inflation, trade, and investment.
Factors that affect exchange rates
The foreign exchange rate plays an important role in the economy of a nation. Factors that affect the fluctuation and variation in the exchange rate –
- Inflation Rates
- Interest Rates
- Country’s Current Account/Balance of Payments
- Government Debt
- Terms of Trade
- Political Stability and Performance
- Economic cycle (expansion, recession, peak or through)
- Speculation by the market participants, banks, importers and exporters etc.
Effect of Crude Oil on the exchange rates
- 1947 (When India became a member of IMF): Indian Rupee tied to pound, INR 1 = 1 s, 6 d, rate of 28 October 1945
- 18 September 1949: Pound devalued; India maintained par with the pound
- 6 June, 1966: Rupee is devalued, $1 = INR 4.76 , after devaluation, $1 = INR 7.50 (57.5%)
- 18 November 1967: the UK devalued pound, India did not devalue
- August 1971: Indian Rupee pegged to gold/US dollar, international financial crisis
- 18 December 1971: US Dollar is devalued
- 20 December 1971: Indian Rupee is pegged to pound sterling again
- 1971-1979: The Indian Rupee is overvalued due to India’s policy of import substitution
- 23 June 1972: the UK floats Pound, India maintains a fixed exchange rate with Pound
- 1975: India links Rupee with a basket of currencies of major trading partners. Although the basket is periodically altered, the link is maintained until the 1991 devaluation.
- July 1991: Indian Rupee devalued by 18-19 %
- March 1992: Dual exchange rate, Liberalized Exchange Rate Management System
- March 1993: Unified exchange rate: $1 = INR 31.37
- 1993/1994: Indian Rupee is made freely convertible for trading, but not for investment purposes
Crude oil is quoted in US Dollars. So, each uptick and downtick within the dollar or within the price of the commodity generates an instantaneous realignment between the greenback and various forex crosses. These movements are less correlated in nations without significant petroleum reserves, like Japan, and more correlated in nations that have significant reserves like Canada, Russia, and Brazil. India imports its major share of petroleum from Iraq, Iran, and Saudi Arabia and pays for it in US dollars.
Oil prices and imports are rising continuously. This pushes up the demand for the US Dollar, which strengthens the US Dollar against the Indian rupee, and therefore the Indian rupee is continuously depreciating. This erodes the purchasing power of the Indian currency within the international market. The domestic oil supply augmentation and control over oil demand seem to be a viable policy choice to overcome the rate of exchange depreciation and its consequences.
Chronology of India’s exchange rate policies
USD to INR Rates Table
1991 – 2000’sIn 1991, India still had a hard and fast rate of the exchange system, where the rupee was pegged to the worth of a basket of currencies of major trading partners. At the top of 1990, the government of India found itself in serious economic trouble. The government was just on the brink of default and its exchange reserves had dried up to the point that India could barely finance three weeks’ worth of imports.
Similar to 1966, high inflation was there along with large government budget deficits and a poor balance of payments position. At the beginning of 1985, the problem with the balance of payments began in India. Even as exports continued to grow through the last half of the 1980s, interest payments and imports rose faster in order that India ran consistent accounting deficits.
Additionally, the government’s deficit grew to an average of 8.2% of GDP. As in 1966, there was also an exogenous shock to the economy that led to a pointy worsening of the already precarious balance of payments situation. In the case of the 1991 devaluation, the Gulf War led to a much higher import thanks to the increase in oil prices. The trade deficit of US $9.44 billion was incurred in 1990 and the current account deficit was US $9.7 billion. Also, foreign currency assets fell to US $1.2 billion.
However, as is the case with the India-Pakistan war of 1965 and further the drought during an equivalent period, India’s financial woes can’t be attributed exclusively to events outside of the control of the government this time. Since the Gulf War had international economic effects, there was no reason for India to be harmed quite like other countries. Instead, it simply further destabilized an already unstable economic situation brought on by inflation and debt. In July of 1991, the Indian government reduced USD to INR value by around 18 to 19 percent. A change was brought in the national trading policy by the government where it went from being highly restrictive to freely tradable EXIM scrips.
It allowed exporters to import 30% of the worth of their exports. In March 1992, the government decided to determine a dual-rate of exchange regime and abolish the EXIM scrip system. Under this regime, the government allowed importers to buy some imports with the foreign exchange valued at free-market rates and other imports might be purchased with the foreign exchange purchased at a government-mandated rate. In March 1993, the government then unified the rate of exchange and allowed, initially, the rupee to float. From 1993 onward, India has followed a managed floating rate of the foreign exchange system.
Under the present managed floating system, the rate of exchange is decided ostensibly by the economic process, but RBI (Reserve Bank of India) plays a big role in determining the foreign exchange rate by selecting a target rate and buying and selling foreign currency so as to satisfy the target. Initially, the USD to INR was valued at 31.37 but the RBI has since allowed the rupee to depreciate against the dollar.
The economic disruption due to the spread of the novel coronavirus disease (COVID-19) over the past few months has adversely affected various aspects of the Indian economy. To observe the impact, one could look at the growth rates of gross domestic product and gross value added. Or, in the absence of such data, one could treat other data like sales of automobiles, etc. as a proxy. In this regard, the exchange rate of the rupee can also be an apt marker on the state of the Indian economy’s competitiveness. Due to COVID 19 global pandemic, US Dollar to Indian Rupee exchange rate is at an all-time low. If the US dollar is stronger than the rupee, then it shows that the demand for US Dollars (by those holding Indian Rupee) is more than the demand for Indian Rupee (by those holding US Dollars).
Typically, stronger economies have stronger currencies. For instance, the US economy is relatively stronger than India’s and this is reflected in one US dollar being equal to around 74 rupees. The Indian rupee has been losing value (or depreciating or weakening) against the US dollar over the past few months. But the US is not the only other country in the world; India trades with many other countries. The Reserve Bank of India tabulates the Indian rupee’s Nominal Effective Exchange Rate (NEER) in relation to the currencies of 36 trading partner countries.
This is a weighted index, that is, countries with which India trades more are given greater weight in the index. A decrease in this index denotes depreciation in Indian rupee’s value; an increase reflects appreciation. In NEER terms, the rupee has depreciated to its lowest level since November 2018. The rupee has been steadily losing value, showing the Indian economy’s reducing competitiveness, since July 2019. The dip in March 2020 was likely influenced by the net outflow of foreign portfolio investments from the Indian equity and debt markets, they stood at $15.92 billion in March as against net inflows of $1.27 billion in February.
There is one more measure that is even better at capturing the actual change. It is called the Real Effective Exchange Rate (REER) and is an improved version of NEER because it takes into account the domestic inflation in the various economies.
After fresh escalation within the US-China trade tension, the Chinese government depreciating its Yuan, and therefore the US President Donald Trump levying duty on the Chinese imports, the emerging economies are expected to receive its impact and so do the national currencies of the emerging economies. As per the market experts, Yuan is that the lead indicator of emerging markets and India isn’t an insulated part of this. So, if the Sino-US trade war is hitting Yuan, so does the Indian National Rupee (INR). This may end in USD to INR at an all-time high and can hit India’s economy