What is Exchange Rate?
Historical Background
Key Points
10 points- 1.
Expressed as units of foreign currency per unit of domestic currency (e.g., USD 1 = INR 83) or vice versa.
- 2.
Appreciation: When a currency gains value relative to another (e.g., INR 80 to INR 75 per USD, meaning less rupees for one dollar).
- 3.
Depreciation: When a currency loses value relative to another (e.g., INR 80 to INR 85 per USD, meaning more rupees for one dollar).
- 4.
Primarily determined by the demand and supply of currencies in the foreign exchange market.
- 5.
Key influencing factors include interest rate differentials, inflation differentials, current account balance, capital flows, government policies, and speculative activities.
- 6.
Nominal Exchange Rate: The quoted market rate, unadjusted for inflation differentials.
- 7.
Real Exchange Rate: The nominal exchange rate adjusted for relative price levels (inflation) between countries, reflecting purchasing power.
- 8.
Impacts international trade: depreciation makes exports cheaper and imports more expensive, while appreciation has the opposite effect.
- 9.
Central banks (like RBI) manage exchange rate volatility through interventions, such as buying or selling foreign currency reserves.
- 10.
A stable and competitive exchange rate is crucial for a country's external sector stability and economic growth.
Recent Developments
3 developmentsThe Indian Rupee has experienced significant depreciation against the US Dollar in recent years, driven by global factors (e.g., US Fed rate hikes, crude oil prices, geopolitical tensions) and domestic trade dynamics.
RBI has actively intervened in the forex market to curb excessive volatility and prevent sharp depreciation, utilizing its foreign exchange reserves.
Debate continues on whether a depreciating Rupee is beneficial for boosting exports or detrimental due to imported inflation and increased external debt servicing costs.