The document discusses the key factors that influence exchange rates between the Indian rupee and US dollar over time. It outlines the historical devaluations of the rupee from 1947 onwards due to wars, inflation, and economic liberalization that required foreign currency reserves. Exchange rates are determined by market forces since 1993 and are influenced by interest rates, trade balances, money supply, inflation, economic growth, foreign debt levels, and short-term factors like central bank interventions and capital flows. Understanding these influences is crucial for assessing financial and economic developments.

1. Presented by:
Abhishek
Chandrakant
Piyush
Neelutpal
Tarun
1

2. Introduction
• The exchange rate is a key financial variable that affects decisions made
by foreign exchange investors, exporters, importers, bankers, businesses,
financial institutions, policymakers and tourists in the developed as well as
developing world.
• Exchange rate fluctuations affect the value of international investment
portfolios, competitiveness of exports and imports, value of international
reserves, currency value of debt payments, and the cost to tourists in
terms of the value of their currency.
• Movements in exchange rates thus have important implications for the
economy’s business cycle, trade and capital flows and are therefore crucial
for understanding financial developments and changes in economic policy
2

3. Genesis of the Rupee-Dollar relationship
• The Rupee-Dollar parity of 1947: When India achieved independence in 1947, there were no external
borrowings on India’s balance sheet! The exchange rate as on 15 August 1947 was 1 US$ = 1 INR. With
the introduction of five year plans, Indian government needed foreign borrowing and this required the
devaluation of the Rupee. The trend was exacerbated by the Indo-China war of 1962 and the Indo-
Pakistan war of 1965 which forced the government to further devalue the Rupee as the country was in
dire need of USD for importing weapons
• Devaluation during the high inflation period of 1970s: In the year 1966, under the prime minister-ship
of Mrs. Indira Gandhi, inflation was increasing at an unprecedented rate. This was also a time when
India was under immense pressure from the US to devalue the Rupee to safe-guard the aid received by
India from the US. This led to the Rupee being devalued to 1 USD=7 INR.
3

4. • Devaluation after the economic liberalization of 1991: The economic liberalization in 1991 under the
prime minister-ship of Narsimha Rao brought with it a sharp devaluation of the Rupee. At that time the
Indian Forex reserve dropped to multi-year lows and a point came when India had only enough forex to be
able to pay for 3 months of Import bills! To fill in this gap India borrowed large amounts from the
International Monetary Fund’s (IMF) with an obligation to devalue the Rupee. The Rupee hit new lows
with 1 US$ = 24.58 INR by the early-nineties from Rs.16.31/1 USD towards the end of the previous decade
4
• The strong dollar period of 1980s: After 1970, USD grew
stronger against the Rupee under the incompetence of
Indian politics coupled with robust economic growth in
the US. The exchange rate in 1970 was 1 USD= 7.47 INR,
which rose to 1 USD=8.4 INR in 1975, after the political
uncertainty following the assassination of Mrs. Gandhi
in 1984. The next round of weakness in the Rupee came
in the wake of the Bofors scam which toppled Rajiv
Gandhi’s government plunging the Rupee to new lows of
1 USD= 12.36 INR in the year 1985. In the year 1990 this
rose to 1 USD =17.5 INR

5. Exchange Rate Policy since 1947
• From 1947 to 1971, the Indian Rupee had a fixed exchange rate under the
per value system of the IMF
• From 1971 to 1975, exchange rate of the rupee was pegged to the value of
pound sterling, and from 1975 to 1991, to a basket of currencies.
• Partial convertibility of rupee, on current account, was introduced in 1992,
and full convertibility in 1993
• Since 1993, exchange rate is determined by the market forces of demand
and supply (Floating Exchange Rate system)
5

6. Nominal Effective Exchange Rate (NEER)
• The nominal exchange rate is simply the price of one currency in terms of
the number of units of some other currency. This is determined by flat in
a fixed rate regime and by demand and supply for the two currencies in
the foreign exchange rate market in a floating rate regime.
• It is 'nominal' because it measures only the numerical exchange value, and
does not say anything about other aspects such as the purchasing power
of that currency. In a floating rate regime, an increase in the value of the
domestic currency against other currencies is called an appreciation, while
a decrease in value is called depreciation.
6

7. Real Effective Exchange Rate (REER)
• To incorporate the purchasing power and competitiveness aspect and,
therefore, make the measure more meaningful, real exchange rates are
used. The real exchange rates are nothing but the nominal exchange
rates multiplied by the price indices of the two countries.
• This means the market price level of goods and services, given by indices
of inflation. So if the price level in the US is higher than the price level in
India, then the real exchange rate of the rupee versus the dollar will be
greater than the nominal exchange rate
7

8. 8

9. Purchasing Power Parity Theory
• Exchange rates adjust to make goods and services cost the same everywhere
• An application of the law of one price
• If the rate of inflation is much higher in one country, its money has lost
purchasing power over domestic goods. Currency depreciation to restore
parity with prices of goods abroad
• Absolute Purchasing Power Parity- The equilibrium exchange rate between
two currencies is equal to the ratio of the price levels in the two countries.
• Relative Purchasing Power Parity- The changes of exchange rates are
proportional to the relative changes of two countries’ prices in a certain
period.
9

10. Theory of Interest Rate Parity
Covered Interest Rate Parity
• The premium or discount ratio of the forward exchange rate equals the
difference between two countries’ interest rates.
• If home interest rate is higher than foreign interest rate, there will be a
premium in the forward exchange rate.
• If home interest rate is lower than foreign interest rate, there will be a
discount in the forward exchange rate.
Uncovered Interest Rate Parity
• The expected changing ratio of future exchange rates equals to the
difference between two countries’ interest rates.
10

11. Balance of Payments Approach
• The balance of payments consists of a current account and a financial and
capital account whose sum is 0.
• The current account is mainly determined by exports and imports.
• The capital and financial account is mainly determined by home interest
rate, foreign interest rate and the expectation of future exchange rate
• The equilibrium exchange rate can be depicted as a function of the
Balance of Payment equation which constitutes all these factors.
11

12. Asset Market Approach
• Monetary Approach- In the monetary approach the exchange rate for any
two currencies is determined by relative money demand and money
supply between the two countries.
• The portfolio-balance approach allows relative bond supplies and
demands as well as relative money-market conditions to determine the
exchange rate.
• The essential difference is that monetary-approach models assume
domestic and foreign bonds to be perfect substitutes, whereas portfolio-
balance models assume imperfect substitutability
12

13. 13

14. Interest Rate
• When interest rate in home country is higher than other country,
more foreign investor will be attracted to invest in home country to
make capital gain. In this case demand for home country’s currency
will increase and may cause it to appreciate.
14

15. Balance of Payment
• When in country’s balance of payment the
export is greater than import we call there
is surplus. Normally it has seen the
country which face the surplus there
currency value increase than country
which make deficit.
• The other way to look at it is that when
exports are more than imports, more
importers will sell foreign currency that
received by exporting which increases
demand for home currency which results
in appreciation of currency.
15

16. Money Supply and Inflation
• At the time central bank of country will print more money, the
supply of money will increase in the market. Which results in
increase in purchasing power of customer also and which
ultimately increases inflation.
• Since inflation and currency value are inversely related, with
increase in inflation currency depreciates.
16

17. Economic Growth
• When the economic growth of a country is high FII would divert
there investment to such growing economy by selling their
investments in other countries, which increases supply of
currencies of those countries of which FII’s are selling investment
causing it to depreciate and the currency of country, in which FII’s
are diverting their investment, appreciates.
17

18. Foreign Debt
• With borrowing comes an obligation to repay the money along with
interest. So when a country borrows more foreign debt it need
more foreign currency to repay that loan, which makes it to sell
more home currency to buy foreign currency resulting in
depreciation of home currency.
18

19. Basically all these factors are linked to each other.
For example:
• When home currency appreciates too much that affects exporters because
now when they receive their payments in foreign currency, after it
conversion in home currency they receive less amount because of
increased home currency value. At this point RBI intervenes and sells
home currency to reduce it’s value, now when RBI is selling home currency
it increases supply of home currency which results in inflation, now to
control inflation RBI increases interest rates, as interest rates increases it
affects economic growth as it increases cost of borrowing, so companies
prefer to borrow from foreign markets as it’s cheaper than home loans
which results in increased foreign debt, which disturbs balance of
payment.
19

20. Short Term Factors
• Central bank intervention: Buying and selling of foreign currency in the
market by the Central Bank with a view to increasing the supply or
demand, there by affecting the exchange rate, is known as intervention.
• Export receipts and import payments: The difference between the total
receipts from export bill realizations and import payments on a given day
in a country determines the exchange rate to some extent.
• Foreign investment flows: Both foreign direct and portfolio investment
inflows and outflows affect the exchange rates.
• Political factors: Factors like war. Announcement of election results, oil
price increase etc will cause exchange rate fluctuations.
20

21. • Speculation: If a few big speculators start buying a currency in an
aggressive manner, others may follow suit. Thus, the demand of the
currency may increase.
• Capital Movements: Movement will be caused by external
borrowings and assistance. Large-scale external borrowing will have
favorable effect on the exchange rate of the country’s currency.
21

22. 22