Monday, July 20, 2009

Factors Impacting the Rupee Movement

It is important for the interested readers to understand how various factors impact the Rupee Movement, both in short term and long term, against other major currencies. I have made a sincere attempt herein to brief major factors. I would like to listen the readers’ views also on this subject.

Economic Growth

A strong economy means a strong currency. Economic strength of a country improves its status among other major economies. Better image brings in more capital inflows into the country mainly through direct (FDI) and portfolio investment (FII) route. Higher inflows improve the demand for the local currency. For instance, India showing a stronger growth amidst a gloomy global scenario, has invited a huge FII inflow in the recent times.

Fiscal Deficit & Sovereign Rating

Every country has a credit rating arrived by international rating agencies such as S&P, Moody etc. The rating is arrived mainly on the basis of the fiscal burden of the federal government vis-à-vis the size of economy. India fares badly here. Fiscal deficit of our central government is hovering around 10% according to some unofficial estimates. As of now, India is rated at the lowest rung of the investment grade. Any further degrading will have a serious impact of our Rupee’s position. Rating of the corporate from a particular country can hardly be better than the rating of their government. So raising of funds abroad by Indian companies becomes a costly affair resulting in forex inflows becoming scarcer.

Trade Deficit

Higher exports mean higher availability of foreign currency. Higher imports mean scarcity for foreign currency. Countries like China have a huge kitty of foreign currency thanks to their huge exports. India has always been an importing country. In particular, oil import is a huge burden for us even though IT exports and remittances from NRIs help to bridge the gap to some extent.

Interest Rate Differential

Every country has a different interest rate structure. Money originating from lower interest rate countries like Japan and US chase the assets with higher interest rate in countries like India. In fact, interest rates in Japan and US are close to zero level. For them, some thing is always better than nothing. Such high interest rate differences led to the “Yen Carry Trade” that near lasted for a decade.

Government Policies

Inflation and exporters’ interest are the major factors driving the government intervention in a “not fully convertible currency” environment like India. Higher inflation would induce the monetary authorities like RBI to push for a stronger Rupee through which the import costs can be reduced. At the same time, RBI may push for a weaker Rupee to increase the competitiveness of Indian exports abroad.

Above factors can be measured from the various reports published by the Government of India and RBI from time to time. Following data are crucial to understand the Rupee’s position vis-à-vis the world’s currency i.e. US Dollar.

GDP Growth
Industrial Production
Forex Reserves with RBI
Exports-Imports Data
Fiscal Deficit of the Government of India
Monetary Policy of RBI
Global interest rates
Stock Market movements
FII/FDI flows

I invite readers’ view on the above subject

With best wishes

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