Why is Indian Rupee falling - Mystery of Rising Dollar Prices

 Why is Indian Rupee falling - Mystery of Rising Dollar Prices

                                        

                                                                   

 The Rupee has been falling dramatically against the dollar in recent months, rupee weakened to an all-time low trading nearly 79.33 to the dollar. This has foreign funds rushed to safety institutional investors, overseas investors have pulled out well over 1 lakh 32 000 crore from the indian market as lockdowns in china and the ukraine war in fear of higher interest rates sent a nervous jolt to the markets essentially when rupee depreciates everything we import gets more expensive. In the month of april, the indian rupee hit a 9 month low of 75.4 against the u.s dollar and had lost nearly 4.2 percent over the last three weeks this made the indian rupee one of the biggest losers in the emerging market currencies and then it went further down to 77.63 rupees per dollar now as soon as this happened there was a lot of panic among the retail investors but you know what guys while most of us think about currency depreciation as just a bad thing very few of us know that when the value of currency drops it brings both advantages and disadvantages along with it in fact sometimes even giant countries purposefully devalue the currency just to grow their economy.

 So the question is how is it even possible that a drop in value for currency can actually benefit a particular country? why do countries purposefully devalue their own currency? and most importantly as investors what are the lessons that we need to learn about the change in value of a particular currency?To understand this let's start from the basics with the meaning of devaluation people we all know that the current dollar to rupee exchange rate as in while the time that i'm writting this blog i have to pay 79.33 rupees to purchase one dollar. So tomorrow if India decides to lower this to a fixed 85 rupees then it is said that INR has been devalued so now i would have to pay 85 rupees to purchase one dollar this is what devaluation of a currency is so in technical terms devaluation is an activity undertaken by the monetary body of a country to officially lower the value of a country's currency within a fixed or pegged exchange rate and usually this is done against the u.s dollar and right now what's happening is not devaluation but the depreciation of Indian rupee based on the demand and supply of rupee.

 So it's definitely not deliberate but you know what guys while most of us think that this fall is a disaster it's not actually that straightforward to conclude because like i said before along with disadvantages there are several advantages that come along with it so let's try to understand both these aspects using two simple case studies.

The first country that we have is none other than china now as a citizen of India i kind of feel intimidated by china but as a student of business and geopolitics i must admit that china is by far one of the greatest and one of the bravest countries in the world and one of these bold moves that they actually made was to devalue their currency in 2015. china shocked the world with a major devaluation of its currency in the move that's going to have effect on both investors and politicians tuesday u.s stocks came under pressure after an unexpected move overnight by the people's bank of china to depreciate the yuan by nearly two percent. The chinese economy has been weak and getting weaker they need to loosen policy the expectation is u.s multinationals and their earnings will get hurt by a weaker yuan and a stronger u.s dollar this is a story that dates back to 2015 and since the past 10 years from the year 2005 to 2015 the chinese yuan grew steadily against the dollar and appreciated close to 33 as a result it had created a lot of positive sentiment amongst the investors but this is when suddenly the people's bank of china which is like the chinese version of RBI they announced three consecutive devaluations of their own currency and the chinese yuan dropped by 4 this created such a panic situation amongst the investors that even the stock markets across u.s and europe started falling so the question is why did china devalue its own currency and how did it benefit from it.

Well there were two reasons that were stated for that number one as we all know china was a very well known exporter of goods and commodities to many countries on top of that it was literally a manufacturing paradise with more than 20 of the entire world's manufacturing happening in china itself but at the same time if you check the graph the GDP growth of the country had been slowing down massively from 2008 to 2015. so in order to boost the exports china decided to devalue the currency deliberately so now the question is how does this devaluation benefit china to put it simply one dollar was equal to 6 yuan in 2015 so if a company like apple wishes to buy 500 million worth of raw material from china in dollar value this would be worth 83.33 million dollars but after china devalued its currency to 6.12 yuan to the dollar the same company will only have to pay 81.69 million dollars for those goods so when a country devalues its currency it reduces the cost of a country's exports making it more competitive and attractive in the global markets.

 For example Vietnam, Bangladesh and Indonesia greatly rely on their footwear and textile exports and this is primarily dependent on cheap labor. as soon as china devalued their currency the labor in china became cheaper and these countries actually lost a ton of business during that time and needless to say the chinese exports actually started growing so while export heavy industries actually got benefited the import heavy industries actually got affected for example if a chinese soap manufacturer imports palm oil worth 500 million dollars at 6 yuan to the dollar she would have to pay 3 billion yuan but post devaluation for the same 500 million dollars worth of palm oil she would have to cough up 3.06 billion yuan. So after devaluation the cost of soap and every other import based products will increase resulting into inflation this is the second outcome of devaluation.

 Thirdly when import cost increases it is expected to incentivize the domestic production the highlight word being expected for example in India when an import duty was imposed on the chinese imports the cost of these imports went up and suddenly there was a very huge demand for domestic production of solar wafers eventually it ended up benefiting the Indian industries. So whenever the cost of import increases whether that's due to devaluation economic crisis or even war the domestic industries stand to benefit the catch over. Here is that they will benefit only if they are ready to embrace the demand for example if suddenly the cost of semiconductor imports increases Indian industries can in no way benefit from it because we don't even have the capability to compete with Taiwan yet, so it would be incorrect to say that devaluation directly Incentivizes domestic industries although there is a chance of it happening why because it's quite subjective to which industry you're talking about what sort of economic condition you're talking about and the condition of those industries to embrace the change and this brings me to the last point which is international repercussions.

You see guys china is the world's largest energy consumer it consumed 145 extra juice in 2020 compared to the us which stood at just 87 exaggerates so you see that's a humongous difference between the two countries so since china is the largest energy consumer china has a major say in how crude oil is priced so when devaluation happened oil price to china went up and china imported lesser oil and during that time the middle east coincidentally was already pumping out a lot of oil so when china cut its oil imports a huge chunk of oil demand went away as a result the oil prices fell down and brent crude went on by 20 and this eventually ended up benefiting countries like India and other countries that imported crude oil and at the same time if you remember during that time president Donald Trump actually got extremely angry at china for currency manipulation and he imposed tariffs on cheaper chinese goods this is what started a massive trade war between the u.s and china until COVID hit us in 2020 and by the way devaluation is not something that's new only to china it is a common occurrence among nations and has a major impact if you are a powerful country like China, US or the European union countries.

                                                         

 So the key takeaway that we have over here is that when the value of your currency goes down there are multiple outcomes.

 Cost of export decreases so if you are in close competition with other countries you have a chance of actually winning back your lost business number two import cost increases so input cost of import based products increases which causes inflation and at the same time it is expected to promote the domestic production and lastly it has international repercussions if you are a major player now the question over here is did it accelerate the GDP of china well not really while the GDP growth of china remained sloppy the exports of china actually increased by an extraordinary rate going from 2199 billion dollars to 2655 billion in 2018 which is an increase of seven percent in just two years so the question is is devaluation of good thing to happen.

 well let's have a look at the other side of the coin and here's where we have the second case study which is the devaluation of the nigerian currency to tell you about it in 1981 for 10 million dollars you could get 6.1 million nairas with the exchange rate being 1.63 nairas for a dollar but over the last 40 years the naira have lost 99.8 percent of its value against the dollar so in 2021 for the same 10 million dollars you would have to pay 4.1 billion nairas and this has come on the back of a series of devaluation efforts made by the central bank of nigeria or CBN in 2020 the CBN adjusted the official rate from 307 nairas to 360 nairas per dollar and then it was further adjusted to 380 nairas per dollar, so when nairas became so cheap it should have boosted the exports of nigeria right because that's what happened in china well guess what that did not happen at all because for exports to increase you need more than just a devalued currency for example if a mobile manufacturing company wants to outsource its manufacturing unit to your country you need to have ports properly built factories well-built roads for transportation and a steady government policy that the company can actually rely on and this was obviously not the case with Nigeria.

 On top of that with such a drastic rate of devaluation the import of goods became extremely costly and inflation rate shot up to 16 in 2021 in fact the price of cements, sand, granite, iron rods and other building materials had risen by 30 and the worst part is that the very purpose of devaluation which was foreign investment that actually started decreasing drastically it went from 24 billion in 2019 to 9.7 billion in 2020 and further dropped to 6.7 billion in 2021. now the point to be noted over here is that this is not just because of devaluation but also because of the pandemic so at the end of the day devaluation just accelerated the trouble for the citizens of Nigeria and now they are facing a very very tough time so these are the two contrasting examples of the outcomes of devaluation and this brings me to the most important part of the BLOG and that are the lessons that we need to learn about devaluation and in general the effect of our currency value.

The first thing we need to learn about currencies is that devaluation of a currency doesn't result in changes overnight it takes time but in the long run as seen in the example with china it could turn out into both benefits if done calculatedly and if not it could ruin your country like nigeria the point we need to do here is that more often than not when devaluation happens it does have immediate impacts such as climatic of stock indices fluctuations in prices of commodities such as crude oil and depreciating currencies of other countries.

Number two, one of the biggest downsides of devaluation is that it would increase inflation and that affects the end consumers like you and me the price of commodities goes up and we end up paying more for living the exact same lifestyle.

 And lastly, it is a common belief that a stronger currency would produce a stronger economy but in reality a stronger economy would produce a stronger currency also. 

 that's all from my side for today guys if you learned something valuable please make sure to read our other blogs too.

Study Tips

Bermuda Triangle full story