Factors affecting the exchange rate of Indian Rupee

As we know that Forex market for Indian currency is highly volatile where one cannot forecast exchange rate easily, there is a mechanism which works behind the determination of exchange rate. One of the most important factors, which affect exchange rate, is demand and supply of domestic and foreign currency. There are some other factors also, which are having major impact on the exchange rate determination. After studying research reports on relationship between Rupee and Dollar of last four years we identified some factors, which have been segregated under four heads. These are:

  1. Market Situations.
  2. Economic Factors.
  3. Political Factors.
  4. Special Factors.

1. Market Situations:

India follows the “floating rate system” for determining exchange rate. In this system “market situation” also is pivot for determining exchange rate. As we know that 90% of the Forex market is between the inter-bank transactions. So how the banks are taking the decision for settling out their different exposure in the domestic or foreign currency that is impacting to the exchange rate. Apart from the banks, transactions of exporters and importers are having impact on this market. So in the day-to-day Forex market, on the basis of the bank and trader’s transactions the demand and supply of the currencies increase or decrease and that is deciding the exchange rate. On the basis of this study we found out the different types of the decisions, which is affecting to market. These are as follows:

  • In India, there are big Public Sectors Units (PSUs) like ONGC, GAIL, IOC etc. all the foreign related transactions of these PSUs are settled through the State Bank of India. E.g. India is importing Petroleum from the other countries so payment is made through State Bank of India in the foreign currency. When State Bank of India (SBI) sells and buys the foreign currency then there will be noticeable movement in the rupee. If the SBI is going for purchasing the Dollar then Rupee will be depreciated against Dollar and vice versa.
  • Foreign Institutional Investor’s (FIIs) inflow and outflow of the currency is having the major impact on the currency. E.g. U.S. based company is investing their money through the Stock markets BSE or NSE so her inflows of the Dollars is increasing and when it is selling out their investments through these Stock markets then outflows of the Dollars are increasing. However if the FIIs inflowing the capital in the country then there will be the supply of the foreign currency increases and Demand for the Rupee will increases and that will resulted appreciation in the rupee and vice versa.
  • Importer and Exporter’s trading is also affecting to the rupee. Like if an Indian exported material to U.S. so he will get his payments in Dollars and that will increase the supply of Dollars and increase of demand of rupee and that will appreciate the rupee and vice versa.
  • Banks can be confronted different positions like oversold or over bought position in the foreign currency. So bank will try to eradicate these positions by selling or purchasing the foreign currency. So this will be increased or decreased demand and supply of the currency. And that will cause to appreciation or depreciation in the currency.
  • As we know that in India there is a floating rate system. In India Central Bank (RBI) is always intervene in the trade for smoothen the market. And this RBI can achieve by selling foreign exchange and buying domestic currency. Thus, demand for domestic currency which, coupled with supply of foreign exchange, will maintain the price foreign currency at the desired level. Interventions can be defined as buying or selling of foreign currency by the central bank of a country with a view to maintaining the price of a given currency against another currency. US Dollar is the currency of intervention in India.

2. Economic Factors:

In the Forex Market Economic factors of the country is playing the pivot role. Every country is depending on its prospect economy. If there will be change in any economy factors, which will directly or indirectly affected to Forex market. Here there are two types of economic factors. These are as follows:

  1. Internal Factors.
  2. External Factors.

Internal Factors includes:

  • Industrial Deficit of the country.
  • Fiscal Deficit of the country.
  • GDP and GNP of the country.
  • Foreign Exchange Reserves.
  • Inflation Rate of the Country.
  • Agricultural growth and production.
  • Different types of policies like EXIM Policy, Credit Policy of the country as well reforms undertaken in the yearly Budget.
  • Infrastructure of the Country

External Factors includes:

  • Export trade and Import trade with the foreign country.
  • Loan sanction by World Bank and IMF
  • Relationship with the foreign country.
  • Internationally OIL Price and Gold Price.
  • Foreign Direct Investment, Portfolio Investment by the country.

3. Political Factors:

In India election held every five years mean thereby one party has rule for the five years. But from the 1996 India was facing political instability and this type of political instability has created hefty problem in the different market especially in Forex market, which is highly volatile. In fact in the year 1999 due to political uncertainty in the BJP Government the rupee has depreciated by 30 paise in the month of April. So we can say that political can become important factor to determine foreign exchange in India.

Due to political instability there can be possibility of de possibility delaying implementation of all policies and sanction of budget. So that will create also major impact on trade.

4. Special Factors:

  • Till now we have seen the general factors, which will affect the Forex market in daily business. And on that factors the different players in the market have taken the decision. But some times some event happened in such a way that it will really change the whole scenario of the market so we can called that event special factors. However traders have to really consider those things and take the decisions. We will see these types of factors in detailed:
  • In the year 1998, when Government of India has done “Pokhran Nuclear Test” at that time rupee has been depreciated around 85 paise in day and 125 paise in seven days. Her main fear was that U.S., Australia and other countries have stop to sanctions the loans So this type of event will have major impact on the market. And due to this the decision procedure of the trader also varies.
  • In the year 2000,India has faced Kargil war, which is also affected to the market. By this war the defense expenditures are raised and due to that there will be increase in the fiscal deficit. And become obstacle in the growth of the economy. So this type of event has impact on the Forex market.

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