The Hindu Business Line : How are rupee-dollar rates determined?

Typically, the value of a currency against another is decided based on demand. If people buy the currency, the currency becomes stronger and vice-versa. The same thing holds for the dollar and the rupee rate. The recent rise of the rupee is because there have been large inflows of foreign money, and since all that money has to be converted to rupees, the value of the rupee has gone up.

Regarding the factors that can influence the change in the rate, there are many. If the currency value is left to marketforces, then the influencing factors are economic growth, strength of the economy, inflation rate, etc. If these factors are favourable, then it is more than likely that the value of that currency will rise as people have faith in the country and will invest more money.

Take, for instance, the case of Zimbabwe. It is in a mess both economically and socially. The economy has been virtually destroyed, with inflation (unofficial) exceeding 4,000 per cent and investors refusing to change hard currency into the Zimbabwean dollar.

The Zimbabwean dollar has taken a major beating for good reason. However, the government there has imposed an artificial rate of exchange and, therefore, the best proxy for the exchange rate is the black market rate which is way above the official rate. Of course exchange rates are also influenced by central banks. In China, the central bank has kept the yuan at a fixed rate against the dollar for a number of years, and only around two years ago did it ease controls, though not fully. Countries ‘peg’ their currencies against other currencies for many reasons. The RBI does not peg the rupee or fix its rate but intervenes in the case of volatility.

Rupee value

We import certain items and had thus hedged forex at Rs 43.50 to the dollar. Now that the dollar has crashed to Rs 40, we have been hit by a double negative. Where do you see the rupee headed in the short and medium terms?

Somnath Chatterjee

In my opinion, I don’t think the rupee will go down much from here in the short run. I think it has reached a floor. In the medium run, I think the rupee will be in the Rs 41.5-42 range. There is too much flux in the rupee market with foreign funds coming in. It just seems almost impossible to judge where the rupee is headed but one thing that is certain is that the rupee is overvalued at current levels.

SUNIL RONGALA
(The author is Economist, Murugappa Group. The views are personal. Send in your queries on economics to Whackonomics@gmail.com)

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How are rupee-dollar rates determined?

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