Introduction
Have you ever wondered why the value of the Indian rupee changes over time? Why sometimes you can buy more dollars or euros with your rupees, and sometimes less? The answer lies in the concept of currency appreciation, which is the increase in the value of one currency relative to another. Let us discuss how currency appreciation works, its causes, and its effects on the Indian economy and society.
What is Currency Appreciation?
Currency appreciation is when one currency becomes more expensive or valuable in terms of another currency. Suppose the exchange rate between the Indian 'rupee' and the US dollar changes from 75 to 70 rupees per dollar. In that case, the rupee has appreciated against the dollar. In other words, one rupee can now buy more dollars than before.
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Currency appreciation is different from currency depreciation. It is when one currency becomes cheaper or less valuable in terms of another.
How does Currency Appreciation Work?
Currency appreciation works through the mechanism of supply and demand in the foreign exchange market, where currencies are tradable. Various factors influence the foreign exchange market.
When more demand for a currency than its supply, its price or value goes up. It happens when more people want to buy or hold that currency for various reasons, such as investing, trading, saving, or traveling. For example, if more foreign investors want to invest in India, they must buy rupees. This scenario will boost the demand for rupees and push up its value.
When a currency experiences an excess supply than demand, its price or value decreases. It occurs when more people seek to sell or dispose of the specific currency. For instance, if numerous Indian exporters wish to sell goods overseas, they convert rupees to foreign currencies. This action raises the rupee supply, thereby lowering its value.
What Causes Currency Appreciation?
Some of the common causes of currency appreciation are:
1. Higher Interest Rates
When a country raises its interest rates, it attracts more foreign capital inflows. The reason is investors seek higher returns on their money. This increases the demand for that country's currency and makes it appreciate. For example, if India raises its interest rates higher than the US, more foreign investors will want to buy Indian bonds or deposits with higher interest rates. This will increase the rupee demand and make them appreciate against the dollar.
2. Strong Economic Growth
When a country's economy is doing well and growing faster than the economies of the countries it trades with, it shows that it is financially solid and stable. This boosts its confidence and reputation in the global market. Because of this, other countries and businesses want to invest money in that country, and its tourism also flourishes. All this increases the demand for that country's currency and makes it appreciate.
3. Positive Market Expectations
When a country has positive market expectations about its future economic prospects or policies, it creates a favorable sentiment among investors and traders. This encourages them to buy or hold that country's currency in anticipation of higher returns or lower risks. This increases the demand for that country's currency and makes it appreciate.
If Indian investors expect a promising budget or reforms, it generates a positive outlook among them. They may consider purchasing or holding onto more Indian rupees, anticipating improved growth or reduced taxes. The higher demand for rupees here leads to their appreciation in value.
What are the Effects of Currency Appreciation?
Currency appreciation can have various effects on the Indian economy, depending on the extent and duration of the appreciation.
Some of the common effects are:
- A stronger currency can make it more expensive for people from other countries to visit your country. This might lead to fewer tourists, affecting local businesses that depend on tourism, like hotels, restaurants, and attractions.
- Currency appreciation lowers the inflation rate in India, reducing the prices of imported goods and services used as inputs or substitutes in the domestic market. This also reduces the pressure on the central bank to raise interest rates to control inflation.
- Currency appreciation can lead to higher unemployment in India, reducing the demand for Indian exports. This can cause a loss of jobs in export-oriented sectors, such as textiles, gems and jewelry, or software.
Conclusion
Currency appreciation is a complex phenomenon that can positively and negatively affect the Indian economy and society. It may benefit some sectors and groups while hurting others. It may also have different effects in the short and long run. Therefore, it is essential to understand its causes and consequences and adopt appropriate policies to manage its impact.
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