How RBI controls the rupee value – Appreciation and depreciation of the rupee
Indian rupee value is of major concern for many. People started to discuss in normal conversation that rupee has fallen a certain percentage with respect to the dollar. and Rupee has increased its value a certain percentage with respect to the dollar. But why does the rupee value fall and how RBI is empowered to control the value of the rupee?
To understand how the rupee value is controlled by RBI, lets go back digging history a little bit and how rupee had dropped to the present value when compared to dollar.
Though we might have experienced a plethora of economic reforms for the past few years and past few decades, one that is remembered in the history of India is the Economic reforms after 1991. The year 1991 was an unforgotten crisis in the Indian economy and at the same time a revolutionizing event as we may call it. It was during this year a great economic crisis is in front of India, and the forex reserves that are available with India at that point of time are enough for just one more week of imports as quoted by many reports.
On August 15, 1947 Indian rupee = 1$. But at that time India has no foreign loans. But later during the five year plans India needed a lot of money for the development of infrastructure and capital building. It borrowed from foreign and slowly to manage the economy government started to devaluate the rupee. Now in 1991, when India needs foreign help to come out of the crisis, It approached the IMF and World Bank. Both of them agreed to provide support but on a few conditions. One such condition is to devaluate the rupee and also make rupee value determined by market forces and not by the central bank. That is the rupee value now is determined by the market forces, not by the government or central bank.
So the rupee value depends on two factors, DEMAND and SUPPLY. In very simple terms if the supply of rupee is more in the economy, then its value decreases and if the supply is less and demand is more, then the value increases. So these supply and demand are in a way controlled by the Imports and Exports of the country including some other factors.
Now even if the value is in the control of the market, the RBI has some power and a role, in fact, to be played to control the rupee value. This is one of the major roles that is performed by the central bank day to day basis to stabilize the economy.
The factors that affect the rupee price are
2. Interest rates
3. Trade deficit
4. Macroeconomic policies
5. Equity market
RBI has tools in its hand to control the rupee price. Some of these tools are Repo rate and Forex reserves are among many others. Now RBI uses these to control the value of the rupee in the market.
Repo rate is the rate at which the bank in the country can borrow money from RBI. In simple terms, it is the interest that is charged by RBI when any bank in India borrows money from it. For example, if the repo rate is increased by the bank, then banks may reduce the borrowing from the bank. Even if they borrow from RBI, they will give this money to the People at a high-interest rate. This also makes the common people refrain from taking loans. Hence, in short, the availability of rupee in the market reduces. And hence the value of rupee increases.
At the same time if the repo rate is reduced, then the bank will borrow money from RBI at a lower rate and hence provide loans to the people at a lower interest rate. Hence there is more chance for the increase in the flow of money in the economy. This results in depreciating the value of the Rupee as there is more supply of rupee in the market.
Now addition to controlling the rate at which it lends to Bank, it also uses the forex reserves to control the rupee value. We all must know that RBI is the sole custodian of FOREX reserves in India. It maintains forex reserves to control the Indian economy in terms of crisis. Now when there is a need to increase the value of Rupee, what RBI does is to pump foreign currency into the market and take away Indian rupee from the market. This results in an increase in the foreign currency supply and a decrease in the Indian currency supply. This results in appreciating the rupee value. And at the same time when there is a need to Depreciate the rupee value, RBI just buys foreign currencies from the market pumping more rupees into the market. This results in an increase of rupee supply and decrease of foreign currency in the market. This results in the depreciation of rupee value.
So this is how RBI keeps a close watch on the value of rupee value to accordingly stabilize its value to suit the economic conditions. But before appreciating and depreciating the value, there are a ton of factors it needs to consider. because a small value of appreciation or depreciation will affect the economy in a large way.
For example, if the value of rupee is appreciated more and more, them the value of exports in the international markets will increase. let me make it Easy. For example today 1$ = 75 rupees( Not exact present value, considered for understanding). Now when we are exporting a product to foreign countries and the price of the product in India after all charges and including profit is 100 rupees. Now if we import it to foreign markets the cost of the product cost in the foreign market is approximately $1.33.
Now consider RBI appreciated the rupee value and now the rupee value is 1$ = 50 rupees. Now consider the same product which is costing 100 rupees. Now if we export it to the international market it costs 2$ in the international product. Hence this product cannot compete with other players and hence we may see a drop in our exports to other countries. If our exports drop, then there is a huge loss to the domestic producers and farmers, who depend on these exports. And also exports are a huge source of income for the country.
Now it is clear how the value of rupee control the imports and exports of a country. This is just a small issue that is affected by rupee values. There are other things that need to be considered.
There are many international laws that also govern how a country controls and how it plays a role in appreciating and depreciating the currency value. All these need to be understood before valuing the rupee.