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Factors that affect currency fluctuations as root sources of continuous changes among currencies: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Unexpected economic data from a specific country Supply-demand factor on currencies. Foreign investment Export/import balance Productivity Growth rate in terms of economical values Unemployment Interest rates Gross National Income of a specific country Deficits of central banks, firms or citizens
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1992: LERMS (Liberalized Exchange Rate Management System) was instituted in March 1992 and Convergence of the dual exchange rates was made effective from March 1993. 1998: Rupee depreciated a lot against Yen. It moved from 30.2357 in 1997 to 36.2409 in 1998 due to East Asian crisis which had a profound effect on the trading activities in East Asian countries including Japan. 1999: Rupee again depreciated again from 36.2409 to 41.9457 in 1999. The Japanese economy enters a recession due to the collapse of land and property prices. The Japanese government implemented a rescue package for Japanese banks following the collapse of the property market and $500bn in bad debts. This led to the sharp appreciation of the Japanese currency against INR. Also, India conducted nuclear tests in 1998 which led to sanctions from Japan which brought about an appreciation of Yen. India experienced some of the fluctuations in the currency that affected the East Asian economies 2001: Following the bursting of the dot com bubble lead to a sharp appreciation of the rupee from 41.7262 to 37.6112. Also, in India Interest rates are cut to their lowest level since 1973, falling by half a percentage point to 6.5%. Japans Financial Services Agency was created in 2000, and launched a special inspection of bank loans in 2001. This finally brought some order to the classification of bad loans, and to the health of banks balance sheets. The exchange rate was quoting in a managed range from 2001 onwards till 2007. It was only after 2003 that the functioning of the banking system in Japan started to improve. The banking crisis only really ended in 2005 when the non-performing loan ratio of major banks declined to a level (2.9 per cent) below the target set by the government. This led to the stability of the exchange rate; however the exchange rate became very volatile in 2007 onwards. The INR/Yen exchange rate jumped from 35.1526 in 2007 to 53.3716 in 2008. The main reason was the subprime crisis. Profits in Japanese banking sector took a 1.2 trillion yen (5.3 billion) hit from the US sub-prime mortgage crisis. Economy of Japan entered into a recession and the global economic slowdown curbed the demand for Japanese exports. Also, Indian economy was not much affected by the ongoing crisis at that time. Indian banks did not have much exposure to the US mortgage market; as a result the crisis did not have a profound effect on India. However, the Japanese economy entered into a recession, which led to the depreciation of rupee. The following graph shows the monthly data for the INR/Yen exchange rate for the years 2010 and 2011:
The above chart shows that there was not much volatility in the exchange rate in 2010 and 2011. It was in the year 2010 that Japan was overtaken by China as the worlds No 2 economy. The Indian government came out with a stimulus package of around $100 billion; one of the major initiative was to keep the exchange rate within a narrow range. There was a devastating earthquake in Japan in Mar 2011, causing widespread damage in Japan. In addition to the loss of life and destruction of infrastructure, the tsunami caused a number of nuclear accidents. Though the loss was huge, this did not have much impact on the exchange rate. INR appreciated slightly in April 2011, because Bank of Japan offered 15 trillion (US$183 billion) to the banking system in an effort to normalize market conditions. INR appreciated because Japanese firms and investors repatriated their assets, selling dollars to prepare for the cost of building their domestic economy, which would have pushed yens value up had the central Bank of Japan not intervened in the market.
The Pound has appreciated viz-a-viz Rupee from the year 1993 to the year 1997 continuously. It is interesting to see that the Pound has eroded its value during this period from 78.1861 to 90.8148, which means that value of Rupee has eroded more than the Pound during this period.
Year 1991 1992 1993 1994 1995 1996 1997 Pound (Jan 2005 = 100) 87.9457 85.5692 78.1861 79.6884 76.8084 78.4961 90.8148
India, affected by the Asian Currency Crisis, suffered and Rupee depreciated about 10% from 65.19 in the year 1996 to 71.1 in the year 1997 against Pound. In the year 1998, India conducted nuclear tests that led many countries to impose economic sanctions on it. Due to this, Rupee lost value against major currencies including Pound.
In the year 2001, the dot com bubble-burst leading to cut in Interest rates o their lowest level since 1973, falling by half a percentage point to 6.5% in India. Similarly, UK too cut its interest rate from 6.5% to 4%. Pound appreciated sharply from 69 in the year 2001 to 84.84 in the year 2004 due to the RBI cutting interest rates to 4.5% in the year 2004. Interest rates in UK remained at unchanged for sometime only to increase to 6% in the year 2006 when the interest rates were at the 5.25% in India. This led to Pound appreciating to 87.7. Pound depreciated sharply from 87.7 in the year 2006 to 75.78 in the year 2009, thanks to the subprime crisis in the US that spread rapidly to the Europe and affected the whole world. India, whose banks did not have large exposure to US, did not get affected badly experiencing a slowdown in the economy. UK got into recession for few quarters forcing Bank of England to cut interest rates to their lowest levels in decades. During this time, interest rates in India were very high leading to depreciation of Pound viz-a-viz Rupee. The following graph shows the monthly data for the Rupee/Pound exchange rate for the years 2010 and 2011:
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UK was the 6th largest economy in the world in terms of nominal GDP and the 8 th largest in terms of GDP (Purchasing Power Parity). From the graph, it is clear that the movement of Pound has been very volatile. Its depreciation from above 74-levels to 68.5 in June, 2010 marks the most important phase of the UK economy
as it managed to come out of recession in the month of February. Interestingly, the credit card interest rates touched their peak during this month. Exchange rates have broadly remained in a narrow range amid uncertainty in the recovery in US and Europe while India is struggling from stagflation (high inflation, slowing growth). RBI has raised the repo rate about a dozen times in the last 15 months indicating high inflationary pressure. The exchange rates are expected to remain volatile in the next two quarters as Europe (including UK) is struggling to recover and get back to the path of growth. Moreover, UK is expected to have the slowest growth amongst the G7 economies which is a matter of grave concern.
Dollar became a dominant international currency following World War II. During Bretton Woods system most currencies were pegged to dollar, much trade and finance was done in dollars and international reserve currency was the dollar. Although International Economy has changed dramatically but still the dollars performance in international currency markets has absolutely enormous implications for American and foreign investors, speculators and other countries alike. Behavior of dollar has dramatic effects on the equity markets, bond markets, interest rates, commodities and trade markets globally. With this in view lets study the trend in INR vs USD exchange rate. The following is a graphical representation of the exchange rate from 1992-2009
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Major trends that have affected the INR/USD equation. In 1991 the government undertook a comprehensive plan to deal with the crisis, among which, one was to devalue the exchange rate and transform the system from a discretionary, basket
pegged system, to a market determined, unified exchange rate. The Rupee was devalued by 18%. Since 1993, the exchange rate has exhibited fluctuations that have been more severe during the crisis period. In 1994, the rupee became convertible on the current account and the process of integration of the Indian financial market with the rest of the world is underway. Several types of exchange controls have been dismantled and the Indian rupee is no longer pegged. The Reserve Bank of India (RBI) however, continues to follow a policy of dirty or managed floating.
The year 1995-96 witnessed periodic speculative pressures on the exchange rate of the rupee, and the exchange rate of the rupee vis--vis the US dollar depreciated from a monthly average of Rs. 31.6 in August 1995 to Rs. 36.6 in February 1996. While some easing of the nominal exchange rate of the rupee during this period was consistent with economic fundamentals and maintaining India's competitiveness abroad, speculative pressures had led to an overshooting. The RBI's policy responses to counter speculative pressures against the rupee were effective in restoring stability in the foreign exchange market and correcting the demand-supply imbalance. The exchange rate of the rupee per US dollar recovered to Rs. 34.4 in March 1996 and further to Rs. 34.2 in April 1996. The foreign exchange market has moved in an orderly fashion from 1996-97. The exchange rate of the rupee vis-a-vis the US dollar moved in a narrow range of Rs. 35.0 to Rs. 35.9 between May 1996 and January 1997. However, the rate of inflation in India, which was significantly higher than the inflation rates in India's partner countries, tended to offset the competitive advantage gained by the nominal depreciation of the rupee.
The Asian crisis saw higher volatility of the Rupee Dollar exchange rate from NovemberDecember 1997 to May-July 1998. The RBI used its intervention strategy to temper the volatility of the exchange rate following periods of large fluctuations in the exchange rate during the crisis period. Monetary policy was tightened in a phased manner from November 1997 onwards as RBI interventions were deemed inadequate in controlling the volatility of the foreign exchange market. This resulted in an increase in interest rates and increased the reserve requirements. Other than CRR and repurchase operations, the RBI also used export credit and surcharges on import finance. 2000-2006 The period experienced further depreciation of the Indian Rupee as against Dollar and the movement ranged from 1 USD = Rs 44-48. The main reasons for this depreciation were:
1. The prospect of rising interest rates in the US leading to a reduction and even reversal of capital flows to the emerging markets as a whole. 2. This coupled with the defeat of the incumbent BJP government in 2004. Uncertainty about the economic policies of the new UPA government which depended on the support of the left leaning parties led to major fall in the stock markets and further outflow of capital. 3. Rising oil prices put a downward pressure on the rupee because India imports a large fraction of its oil. 4. Rising inflation further fuelled this depreciation. 2007-2008 By mid 2007, the seeds for the subprime crisis had been sown. The sustained foreign investment flows into the country caused a sharp increase in Indian Rupee against the dollar. This posed a lot of problems to the exporters and the BPO firms in the country. The RBI, fearing a further rise of the rupee, accelerated dollar purchases and bought a sum of $70 billion from September 2007 to March 2008 an average of $10 billion a month. But even this did not stop the Rupee from crashing below Rs. 40. By the end of 2007 it traded at around Rs. 39 per dollar. After Lehmans bankruptcy in 2008, the rupee depreciated sharply, breaching the level of Rs.50 per US dollar. The RBI had lost control of the rupee. It scaled up its intervention operations and despite significant easing of crude oil prices and inflationary pressures in the second half of the year, declining exports and continued capital outflows led by global deleveraging process and the sustained strength of the US dollar against other major currencies continued to exert downward pressure on the rupee up to the first quarter of 2009.
2010-2011 Since 2010, the Indian Rupee has relatively stabilized but still remains volatile in the range of Rs 44-46. Concerns about the growth, employment figures, low interest rate and highly leveraged economy in the
US on one hand and high interest rates in India have led to huge capital inflows in the capital which has strengthened the rupee against the dollar. At the same time, concerns over inflation, scams like CWG and 2G, corruption rallies striking workers at various industrial plants, fiscal deficits and issues over corporate governance have raised questions about India being a competitive destination to invest. The Euro debt crisis and its impact on the stock market has also let to the outflow of capital in the recent months. The rupee has been volatile in the range of Rs. 44-46, but is expected to strengthen in the near future due to the positive outlook for economic growth.