The Indian Rupee (₹) has its own ups and down at the foreign exchange. The value of currency goes up and down according to the foreign exchange market. There is a common misconception that a stronger value of currency is good while a weaker one is bad. Let us learn how devaluation of Indian Rupee is a blessing in disguise for the country.
USD, EUR, YEN vs. Indian Rupee
Suppose a bank in the US wants to build an online banking platform. The bank starts looking for a potential IT company to built its product. After a lot of contemplation and research, they decide to partner with Infosys Limited in India. Meanwhile the deal is signed for $100 million.
Since Infosys Limited has to pay its employees, shareholders, bills in India i.e in Indian Rupee (₹). They are more concerned about the money in Indian Rupee.
Fast forward to 1 year, the project is completed and Infosys Limited are rewarded with the money. Now bank (client) pays the money, since the client is based in the US, they pay in dollars. Then Infosys Limited will receive the money in Indian Rupee based on the price set in foreign exchange market (FX).
What makes Indian Rupee Stronger Against USD?
FX market is like any other market. The market has a commodity, a buyer, a supplier and a set price for the commodity. Since the commodity is money, there is a demand and supply of a particular currency.
In the above example, the currency in demand is Indian Rupee. The supply of INR is with the central bank of the US. Hence, the US client will demand for INR and pays Infosys Limited for the project. Balance of demand and supply will create the price for the currency (INR). So the price in FX market is called Exchange Rate.
Demand is proportional to price. When demand increases, price increases. On the other hand, supply is inversely proportional to price. When supply increases, price decreases. In the above example, the client (bank) demands INR from the central bank and let us imagine that 2 more firms require INR. With all this increase in demand, the Exchange Price at FX for INR increases. This leads to INR (₹) becoming stronger against USD ($).
Who is affected from FX?
From the above example, let us imagine the date fixed for payment is 1st January. Infosys Limited is concerned about the INR they will receive on 1st January. The cost for client was $100 million. When the deal was signed, the USD vs. INR was fixed at ₹70. So Infosys expected to receive ₹7,000 cr. (excluding surcharges).
But on 1st January, USD became stronger against INR and the rate for 1 USD becomes₹72. Now, Infosys would receive ₹7,200 cr. (excluding other charges). There was a gradual increase of ₹200 cr. when USD became stronger. Like we had mentioned before, there is a common misconception that a weaker INR becomes problematic for India. This is not always true.
Now imagine an opposite scenario where USD becomes weaker against INR. Now the value of USD becomes ₹68 on 1st January. So, Infosys will incur a loss of ₹200 cr. and would only receive ₹6,800 cr. from the deal.
FX after-effects on Imports and Exports
The above example which we had discussed was when India exports something. In this case, India exported its IT services to the US bank (client). When the currency is weak, exports tend to increase and exporters get more money, thus leading to profitability. The domestic market (of India) can sell goods to more developed economies and receive much more money than it was expected.
On the other hand, imports become excessively expensive. India imports a lot of goods from outside. India imports oil, heavy machinery, plastics, chemicals, etc. When Indian currency gets weak, imports become expensive and all the pressure is on the consumers. This is the reason why India is seeing a rise in crude oil, petrol and gasoline price.
When the equation of imports and exports are not handled properly, it can lead to the breakdown of an economy. Each country in its foreign reserves holds foreign currencies. When imports rise too much and exports become negligible, country suffers. Same lead to the economic collapse of Sri Lanka.
War and pandemic has affected the supply chain and demand is high everywhere. When demand is higher, prices tend to go high. Since these commodities are imported to meet the requirements of Indian consumers, prices go much higher than expected (due to weaker currency + high demand).
USD vs. INR continues to hurt the businessmen in India. Majority of the businessmen in are traders and not manufacturers. Hence, a lot of their businesses depend on the FX (foreign exchange). A lot of students from India go to colleges and universities in the US. Tuition fees is usually paid from India. Every time the value of USD goes up, tension in the family arises. It will be very interesting to see how much the INR might do down in the future. This would be a blessing in disguise for Indian exporters but hell for importers.
👌nice!
thanks! 🙂