You might have seen news headlines like “Indian rupee falling” or “Rupee falls to Rs.70 against US dollar”. Have you ever wondered why rupee is falling? Who fixes the value of the Indian rupee as Rs.70 per 1 US dollar?
Let’s us discuss in this post a few confusing concepts in economics related to the currency market. We shall see in this article, the difference between Rupee Devaluation and Rupee Depreciation.
Let’s also trace the value of Indian rupee with respect to US dollar from 1947 and see how a fall in rupee value affects exports and imports.
Who fixes the value of Indian Rupee against US dollar?
Interesting question. Do you think the Indian government fixes the value of Indian Rupee against US dollar?
If not, who fixes it?
RBI?
No.
At present, none of these entities fixes the value of Indian Rupee. Now the value of Indian Rupee (or any other currency) is determined by the market.
Yes, Market!
Here market means the currency market.
The demand and supply forces in the currency market determine the price of each currency.
If the demand for Indian currency is high, Indian rupee will appreciate (for example 1$ = Rs.40), and if demand is low, it will depreciate (for example, 1$ = Rs.70).
If market forces determine the value of a currency, that type of system is called Floating Rate System. India has adopted the partial floating rate system since 1975, and from 1993 is fully dependent on Floating Rate System.
This means that our Prime Minister, Finance Minister or RBI chairperson cannot fix the currency exchange rate at the click of a button. But they still have some control – through policy measures or by controlling foreign exchange reserves.
Fixed Rate System vs Floating Rate System
If the government or RBI fix the exchange rate of a currency (and does not allow any variations according to demand and supply forces in the market), such a system is called the Fixed Rate system. It is also called the Bretton Woods system or Pegged Currency System.
India was following this kind of system till 1975 and partial controls followed until 1993. Since this currency valuation mechanism is artificial, most of the countries including India changed to Floating Rate System where currency market determines the value of a currency.
Rupee Devaluation vs Rupee Depreciation
The term devaluation is used when the government reduces the value of a currency under Fixed-Rate System. When the value of the currency falls under the Floating Rate System, it is called depreciation.
Revaluation is a term which is used when there is a rise in currency value in relation with a foreign currency in a fixed exchange rate. In the floating exchange rate regime, the correct term would be appreciation.
Note: Altering the face value of a currency without changing its foreign exchange rate is a redenomination, not a revaluation.
History of Indian Rupee: A comparison of Indian Rupee Value vs US dollar
Remember that we were following a fixed rate system till 1975. We had partial controls on currency market till 1993 when as per IMF standards we liberalized our entire economy.
- 1947: 1 US$ = 1.00 INR (Sounds interesting, huh? :-))
- 1948: 1 US$ = 4.79 INR.
- 1965: 1 US$ = 4.79 INR.
- 1966: 1 US$ = 7.57 INR.
- 1971: 1 US$ = 8.39 INR.
- 1985: 1 US$ = 12.0 INR.
- 1991: 1 US$ = 17.9 INR.
- 1993: 1 US$ = 31.7 INR.
- 2000: 1 US$ = 45.0 INR.
- 2013: 1 US$ = 60.0 INR.
- 2017: 1 US$ = 65.0 INR.
- 2018: 1 US$ = 74.0 INR.
The value of the Indian Rupee: Does it matter?
It should not be forgotten that the exchange rate of a currency is not really an indicator of the economic strength of a country.
There are many countries including China which favours the devaluation of the currency.
Also, the economic position of India in 2017 is far better than that of 1947, though there is a fall in Rupee value.
At present what should worry the Finance Minister and RBI governor should not the falling Indian Rupee, but the fluctuations in the currency market. What India needs is stabilization of Indian Rupee value, be in Rs. 50, Rs.60 or Rs.70 per 1 US dollar. But if rupee is Rs.60 one day and if it Rs. 65 the next day, it shows high volatility. Such a situation is not good for the economy and that will only trigger more fall in Indian rupee.
Depreciation and Appreciation of Indian Rupee: Relation with Exports and Imports
UPSC has often asked this question – directly and indirectly – how does a fall in rupee affects exports and imports? Wait, before analyzing this topic let’s see one more question 🙂 Why do governments devalue their currencies?
Answer: They do it mainly to improve the balance of trade (or in other words, to increase exports and decrease imports!).
Exports vs Fall in the Indian Rupee Value: The local currency effect
A devaluation means that more local currency is needed to purchase imports and exporters get more local currency when they convert the export proceeds (the foreign exchange that they get for their exports).
In other words: imports become more expensive; importers lose money while exporters earn more money.
This is supposed to discourage imports – and to encourage exports and, in turn, to reduce trade deficits.
Clear, uh?
Well, that was an explanation with respect to the local currency angle. Let’s see the same case analyzing the volume effect angle as well.
Exports vs Fall in the Indian Rupee Value: The volume effect
Assume that India is the exporting country and America as the importing country. India exports apples to America. Assume that India devalued India rupee from Rs. 50 =1 dollar to Rs.100 = 1 dollar. The cost of an apple in India before and after rupee devaluation is Rs.50. Now analyse what will happen.
- Before rupee devaluation: Americans will get only 1 apple for 1 dollar.
- After rupee devaluation: Now Americans will get 2 apples for 1 dollar.
Think from the American perspective. For them earlier with 1$, they used to get only 1 apple. Now after falling in Indian rupee, they get 2 apples.
So importing from India has become really cheaper for America and they will use this case to their maximum advantage.
This case will favour exporters in India in two ways:
- (1) They can now sell more apples (volume effect), trade volume will increase.
- (2) Indian currency they get when converted is now higher than before. (It was Rs.50 before, now it is Rs.100 – for 1 US$ received)
Thus, every time there is a fall in rupee against US dollar, exporters from India are benefited. (Eg: Software companies, seafood exporters etc.)
This situation badly affects importers or those who wish to visit the US for holidays as they need more local currency to get the same service or product.
Hope the confusing topic is clear for you. Leave your feedback or queries in comments.
arulkumar k says
February 4, 2014 at 10:35 pmthanking you sir .gave this information .i have very weak in geography questions .so h ow to improve geography portion .? .pls give me solution or idea’s . once again thanking you sir ………..
ClearIAS.com says
August 17, 2018 at 3:12 pmPlease refer our easy-to-learn geography notes.
ritesh says
August 8, 2015 at 7:22 pmpls comment on this
for exporters ,only sell will increase ,but money they will get will reman same as before,
because in case of devaluation from 50 to 100rs in example. he will have to sell 2 apples for 100rs , in first case also he was selling 1apple for 50rs. so volume wise he will do more export
rajesh says
October 29, 2015 at 12:31 pm@ ritesh..
wat u r saying is right, when rupee devaluates exports become costly to us nd our products will be cheaper to the other country, hence they anticipate more goods for the same price, consumption increases and our exports increases, but this will not be helpful for much more import dependant country like india coz inorder to export more we should have good amount of production and raw materials but we dont have, wat we actually do is, import diamonds, rough jewellery and export them polished, import crude oil export refined oil that means the things we are borrowing are much much costly for common man in india. main theme is we can export for some time for appreciation of our currency, but since the cost of imports is more, multi party based country(india) people cant bear for such a long time because it require very very long time to recover our trade deficits and turn into a export based market.so it will be beneficial for a country like china to devaluate its currency to some extent to boost exports as it imports less goods.
Prateek says
January 10, 2017 at 12:32 amI found this article very good ,it’s simply explained and interesting
ClearIAS.com says
August 17, 2018 at 3:17 pmThank you for the feedback.
S.Mukherjee says
December 4, 2017 at 11:13 pmMicro or Macro ‘ fix focus point of discussion.
Harish Purohit says
May 6, 2018 at 3:08 pmWhy a import based economy like India and Pakistan would depreciate rupee?
What are consequences and reasons to depreciate local currency?
Please answer considering present conditions of both countries.
ClearIAS.com says
August 17, 2018 at 3:20 pmGood query. For import based countries, depreciating rupee affects the balance of payments, though it may help a few export-oriented sectors like IT. However, no country wishes to be import-dependent and the focus would be to promote export.
M.Haritha says
July 8, 2018 at 4:43 amPls clear with an example sir..how is rupee appreciation stimulating the exports? They will get less amount compared to the rupee devaluation..and how does it affect import as we have to pay only less than compared before
ClearIAS.com says
August 17, 2018 at 3:26 pmFor example, consider that Mr.X is an exporter. And consider that he gets 1$ as profit for every batch of export products. If 1$=Rs.45, he will get only Rs.45 in Indian currency/batch. However, if the rupee depreciates and if 1$=Rs.70, then he will get Rs.70 Indian currency/batch. Thus he earns more in Indian currency if the rupee depreciates.
Anvesh says
August 17, 2018 at 11:04 amI we the Indians sell those two apples at a cost of 50 rs per each we will get 100 rupees even in india then why to sell to america
Dr.Pushpa says
August 17, 2018 at 2:40 pmReally Vry nice explaination and it’s easy to understand ABT falling of currency in India…thank u sir
ClearIAS.com says
August 17, 2018 at 3:28 pmThank you for the feedback.
Thalluru Surendramani says
August 17, 2018 at 3:51 pmSir, really very very very very good explaination. I could see interest that make the students understand concept with simple language, thank you so much
subash sundaram says
August 17, 2018 at 4:45 pmIn Devaluation,exporters get quantity demand only because price is cheaper than other countries.
K T Raja says
August 23, 2018 at 6:20 pmCrystal clear. Thank you:)
ayush rana says
September 17, 2018 at 8:56 pmif there is devaluation of rupee
will there b more currency to b printed
it will not increase the prices of commodity
Tanya garg says
October 14, 2018 at 12:56 pmthank you sir , it really helped in developing a better understanding on the topic. you explained it in a very simple and very clear cut manner. thank you once again.
KRISHNA VAMSI ALA says
December 8, 2018 at 12:11 ami am having one concern, if depreciation takes place does it cause any increase in price of goods. if impacts,how?
Gurjant singh says
December 20, 2018 at 10:43 pmYou are contributing a significant development in shaping our general knowledge skills…Thanks a lot sir
Kumari vijeta says
January 11, 2019 at 7:34 amThe best place for upsc preparations. Facts are very lucid to understand.
.
Shubhi says
March 2, 2019 at 5:36 amThankyou so much sir….
Ankush Ade says
March 3, 2019 at 4:27 pmHats off You sir thanks a lot
Rachana Mohalkar says
March 15, 2019 at 11:37 pmVery Nice…Totally Understood the concept why we become less competitive at international market when there is appreciation in indian rupee..
Thank you so much…
Darshini says
March 16, 2019 at 7:30 pmReally very helpful and explained in a very simple way. Thanku
Karuna K V says
May 10, 2019 at 11:45 amThank you it was really helpful 🙂
Deepti nigam says
May 11, 2019 at 7:51 amWhy does this apple example seem flawed?the cost of apple too is decided by the market in the other country.only benefit i can find is that by selling one apple for one dollar we wiĺ get 100 rs after devaluation instead of 50
Leena Dhakad says
May 18, 2019 at 2:50 pmThank you for this explanation. solved my doubts 🙂
Tabssum says
June 13, 2019 at 9:41 amvery very easily described 😊
Thanks a lot sir🙋♀️