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DR.

RAM MANOHAR LOHIYA


NATIONAL LAW UNIVERSITY

FINAL DRAFT OF

ECONOMICS
On: EXTERNAL VALUE OF CURRENCY
Submitted to:

Submitted By:

Dr. MITALI TIWARI

MONISH NAGAR

Assistant Professor

Roll no: 84

DR. RMLNLU
(Hons.)

BA LLB
Semester III

Acknowledgement
First of all, I would like to thank Dr. Mitali Tiwari for giving me this opportunity to make the
project on such an immense topic and all the support and guidance that I have received from her,
without which this project could not have turned into a reality. I would also like to thank all my
colleagues and seniors for providing me support and material facts and figures related to this
topic. Last but not the least, I would like to thank my parents for providing me appropriate
guidance and support to prepare the project. All the above mentioned people have very whole
heartedly helped me to make this project in the present shape.
-Monish Nagar

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Table of Contents
MEANING OF VALUE OF MONEY:

CURRENCY CONVERTIBILITY- MEANING & DEFINITION;-

EXTERNAL AND INTERNAL CONVERTIBILITY :-

HOW DOES THE EXTERNAL VALUE OF THE RUPEE MATTER?

HOW RUPEE-DOLLAR RATES ARE DETERMINED:-

WHY THE RUPEE HIT 60/UD$:-

WHY IS INDIAN CURRENCY VALUE LESS IN THE GLOBAL MARKET?

THE EFFECT OF CURRENCY FLACTUATION ON THE CURRENCY:-

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CONCLUSION

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BIBLIOGRAPHY AND WEB REFERENCES

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CHAPTER 1

INTRODUCTION AND PLAN OF STUDY

1. RESEARCH QUESTIONS
1. What is currency
2. What is the value of currency?
3. How to convert the currency?
4. How does the external value of the rupee matter?

2. RESEARCH METHODOLOGY
Research Methodology in the making of this Project will be Doctrinal Research
Methodology. This Methodology will be best suited for the Topic of the Project.
Researchers who deal with this type of research mainly concern with the philosophy of
Topic involved. Besides reference from books and journals, documents are given due
weightage which provided the needful contribution required in the proper completion of
the research. Above all, views advocated by eminent personalities is given due
importance.

3. BACKGROUND
The foreign exchange market (is a global decentralized market for the trading of
currencies. This includes all aspects of buying, selling and exchanging currencies at
current or determined prices. In terms of volume of trading, it is by far the largest market
in the world. The main participants in this market are the larger international banks.
Financial centres around the world function as anchors of trading between a wide range
of multiple types of buyers and sellers around the clock, with the exception of weekends.
The foreign exchange market does not determine the relative values of different
currencies, but sets the current market price of the value of one currency as demanded
against another.
The value of a currency expressed in terms of another currency. For example, if an
analyst says one pound is worth two dollars at a given time, he/she is expressing an
external value of the pound. This contrasts with expressing a currency in terms of itself.
External value is the value of a currency as measured in foreign currency (foreign
currencies), which is called exchange of money or exchange value of money. Value of the
currency of a country different from the value of the other countrys currency, hence
currency of a country can not be exchanged for currencies of other countries with the

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same amount. To perform the exchange of foreign currency needed foreign exchange.
Foreign exchange rate is the price of its own currency or the price of foreign currency
expressed in dollars.
Value for money can be divided into two parts, as follows:
a. Nominal value and intrinsic value
Face value is the value written in each currency or the value written on the money itself.
Intrinsic value is the value or price of materials used to make currency.
b. The value of internal and external value
Internal value is the value of money or resources to purchase some goods or services.
Internal value is a real value, that value can be measured by the number of objects that
indicate the purchasing power of money.
External value is the value of a currency as measured in foreign currency (foreign
currencies), which is called exchange of money or exchange value of money.
Currently most of the money made from paper. The current paper money is virtually has
no intrinsic value, but the public would accept the money because public confidence in
money itself. Since the enactment of the bill on the basis of trust, then paper money
called a trust or fiduciary money.
.

some theories about the value of money


a. Inflation. If the circulation of money is too much then it will result in inflation, the
falling value of money is not proportional to the flow of goods and services. If
inflation can not be controlled by the government, there will be hyperinflation.
b. Deflation. If the ratio of the amount of money circulating in the community is
smaller than the flow of goods and services will result in deflation, the rising value of
money and prices will be low or low-cost goods.
c. Devaluation. Devaluation is government policy to reduce the currencys value
against foreign currencies. In the state that issued the policy of devaluation, the price
of goods exports (in foreign markets) to be cheap, so the demand for overseas goods
more or increases, and domestic purchasing power was growing stronger.

MEANING OF VALUE OF MONEY:


By value of money is meant the purchasing power of money over goods and services in a country.
What a rupee can buy in India represents the value of money of the rupee. Thus the phrase, value of

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money is a relative concept which expresses the relationship between a unit of money and the goods
and services which can be purchased with it.
This shows that the value of money is related to the price level because goods and services are
purchased with a money unit at given prices. But the relation between the value of money and
price level is an inverse one. If V presents the value of money and P the price level, then, V =
1/P. When the price level rises, the value of money falls, and vice versa. Thus in order to measure
the value of money, we have to find out the general price level.
The value of money is of two types: The internal value of money and the external value of money.
The internal value of money refers to the purchasing power of money over domestic goods and
services. The external value of money refers to the purchasing power of money over foreign goods
and services.

CURRENCY CONVERTIBILITY- MEANING & DEFINITION;The ease with which a countrys currency can be converted into gold or another currency.
Convertibility is extremely important for international commerce. When a currency is inconvertible,
it poses a risk and barrier to trade with foreigners who have no need for the domestic currency. The
ability to exchange money for gold or other currencies. Some governments which do not have large
reserves of hard currency foreign reserves try to restrict currency convertibility, since they are not in
a position to handle large currency market operations to support their currency when necessary. The
state of or the ease with which a currency may be exchanged for a foreign currency. Currency
convertibility is vitally important in the foreign exchange market; higher convertibility means that a
currency is more liquid and, therefore, less difficult to trade. Factors affecting convertibility include
the availability of foreign currency reserves in a given country and domestic regulations seeking to
protect local investors from bad investment decisions in, say, a currency undergoing a period of
hyperinflation. Currency convertibility refers to the freedom to convert the domestic currency in
tooter internationally accepted currencies and vice versa at market determined rates of exchange. A
few socialist governments even issue inconvertible currencies, such as the Cuban peso, in order to
protect their citizens from perceived capitalist infiltration. Currency Convertibility refers to the
degree to which one currency can be exchanged for another. Some currencies trade less freely on the
open market and exchanges, in these cases, can be more difficult to process.

EXTERNAL AND INTERNAL CONVERTIBILITY :When all holdings of the currency by non-residents are freely exchangeable into any foreign (nonresident) currency at exchange rates within the official margins than that currency is said to be
externally convertible. All payments that residents of the country are authorized to make to nonresident may be made in any externally convertible currency that residents can buy in foreign

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exchange markets. If there are no restrictions on the ability of a country to use their holdings of
domestic currency to acquire any foreign currency and hold it, or transfer it to any nonresident for
any purpose, that countrys currency is said to be internally convertible. Thus external convertibility
is the partial convertibility and total convertibility is the sum of external and internal convertibility.

HOW DOES THE EXTERNAL VALUE OF THE RUPEE MATTER?


Over the course of the last 12 months, the dollar has appreciated by approximately 21.5 per cent.
In the first blush of reforms in 1990, the rupee was devalued by 20 pc over a period of 10 days.
Is the rupee now fairly valued? Can it fall more? Should it fall more?
In a system of market-determined rates, the forces of demand and supply decide these things.
However, we have never had a free market in foreign exchange and the external value of the
rupee was always set by administrative fiat backed up by an elaborate system of exchange
controls.
A part of these controls were dismantled in 1990 with reforms. The rupee has never been
convertible on capital account. The Reserve Bank of India still has a variety of controls on who
may buy foreign exchange and for what purpose in the market.
Apart from direct intervention, the RBI has a variety of other levers with which to guide the
external value of the rupee. Therefore, it effectively sets a fairly defined range in which the
dollar trades in the foreign exchange market. A free market in the $-INR is largely a myth.
Therefore, the correct question to ask is, where should the INR really be and to what purpose.
The exchange rate policy in India was designed in the '50s to achieve certain goals of
development and hasn't changed all that much even after reforms. It is worth considering the
logic behind the foreign exchange policy.
In India, on the other hand, we are in love with a strong rupee and pay scant attention to job
creation. That was because our imports, ignoring gold, are largely petroleum and capital goods,
which are price inelastic, while our exports, besides agricultural commodities like tea, cotton, jute,
sugar etc are an ill-defined basket of goods whose price elasticity is indeterminate.
Since we are a net importer, conventional wisdom dictates that we keep the INR overvalued
in our favour. That policy also favours both our industry and our middle class who are the main
consumers of imported products while it further "taxes" our farmers who are net earners of foreign
exchange.
The situation has changed somewhat with software and services exports where the external
value of the INR directly impacts job creation for the middle class, creating some awareness among
them of how the dynamics of INR pricing works but not nearly enough.
A further factor that closed the minds of our policy-makers in the past to use of agricultural
exports for domestic job creation and growth was the closed nature of export markets for agricultural

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produce in the EU and other developed countries. Import quotas, subsidies to local farmers in these
countries and a variety of other trade barriers shut Indian farmers out of these markets.
That has changed with shifting demographics in these countries and the emergence of China as
the world's largest importer of food and other agricultural commodities. This development has barely
registered in Indian policy circles and intelligentsia despite the fact that it can completely change the
game for Indian farm exports.
The RBI can afford to let the market play a greater role in determination of the external value of
INR for a while without undue panic or worry. India is fundamentally a viable economy
producing far below its potential because of flawed policies. We need to let the market play its
due role in generating pricing signals that guide policymaking. Have faith in yourself and trust
the markets to get the direction right.
Policymaking must not replace the market but follow it in order to fine tune things. If that means
the INR needs to go to 65-80 range before people start investing in farms to grow soya or corn
for export, we should let the market lead the way. It should be obvious that once the exports get
going, the INR will revert to a higher value again.
Equally obvious is the fact if policy-makers facilitate policies that make exports of soya or corn
to China quickly, the INR may not need to go to 65-80 ranges for that to happen.
The depreciating INR creates new opportunities. Rather than fight the markets, it is high time we
learned how to use markets to set the right policies in order to achieve higher growth. Let the rupee
our thinking be free.

HOW RUPEE-DOLLAR RATES ARE DETERMINED:Whether currency movements or prices of mangoes, the most important factor determining their
price is the same market forces of demand and supply.
Ever wondered why the rupee quotes at 53.2 or 50 and not at Rs. 20 or Rs. 80 to a dollar?

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Its not much different from how the prices of your mangoes are determined, for example.
Whether currency movements or prices of mangoes, the most important factor determining their
price is the same market forces of demand and supply.
If the demand for dollars increases, the value of dollar will appreciate. As the quotation for Rs/$
is a two way quote (that is, the price of one dollar is quoted in terms of how much rupees it takes
to buy one dollar), an appreciation in the value of dollar would automatically mean a
depreciation in Indian rupee and vice-versa.
For example, if rupee depreciates, a dollar which once cost Rs. 47 would cost, say, Rs. 50. In
essence, the value of dollar has risen and the buying power of rupee has gone down.
Besides the primary powers of demand and supply, the rupee-dollar rates are determined by other
market forces as well.
Market sentiments
During turbulent markets, investors usually prefer to park their money in safe havens such as US
treasuries, Swiss franc, gold and so on to avoid losses to their portfolios. This flight to safety
would lead to foreign investors redeeming their investments from India. This could increase the
demand for dollar vis--vis Indian rupees.
Speculation
There are derivative instruments and over-the-counter currency instruments through which one
can speculate/ hedge the underlying currency rates. When speculators sense improvements/
deterioration of the sentiments of the markets, they too want to benefit from such rising/ falling
dollar. They then start buying/selling dollar which would further change the demand/ supply of
the dollar.
RBI Intervention
When there is too much volatility in the rupee-dollar rates, the RBI prevents the rates from going
out of control to protect the domestic economy. The RBI does this by buying dollars when rupee
appreciates too much and by selling dollars when the rupee depreciates significantly.
Imports and Exports
Ever give thought as to why our government is trying to incentivise exports and reduce imports?
There are a lot of schemes and incentives for exporters while importers are burdened with many
conditions and taxes. This is to protect our economy from high rupee depreciation. Importing
foreign goods requires us to make payment in dollars thus strengthening the dollars demand.
Exports do the exact reverse.

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Public Debt / Fiscal policy
Whenever our Government fails to match expenses with equivalent revenue, there is a shortage
of funds. To finance this, the Government at times opts to borrow money from institutions such
as the World Bank and the IMF. This debt, accrued interests, and the payments made, also lead to
currency fluctuations.
Interest Rates
The prevailing interest rates on the government bonds attract foreign capital to India. If the rates are
high enough to cover the foreign market risk and if the foreign investor is comfortable with the
fundamentals or credit ratings, money would start pouring into India and thus provide us with a
supply of dollars

WHY THE RUPEE HIT 60/UD$:The combination of circumstances that contributed to the fall in the value of the rupee vis-a-vis
the US dollar was predictable to a considerable extent. But the sharp and sudden fall in the
exchange rate of the Indian currency in relation to the American greenback has taken many by
surprise.
As the rupee appears inexorably headed towards breaking the Rs 55=$1 barrier and touch the Rs
60=$1 mark, the big question that arises is whether this is good for the country.
Under certain circumstances, currency depreciation may not be such a bad thing if it results in
exports going up thus bringing down the trade deficit (the difference between the value of
exports and the value of imports) as well as the current account deficit (the gap between inflows
and outflows of foreign currencies) and the capital account deficit (or the difference between the
inflows and outflows of capital, both in the form of portfolio investments in stock exchanges and
foreign direct investments) in the balance of payments.
But on this occasion, the answer is unequivocally clear: the fall in the value of the rupee portends
ill for the Indian economy.
Export growth has been sluggish and is likely to remain that way for a while. Imports have been
buoyant and since India is currently heavily dependent on imports which cannot be easily
curtailed, the trade deficit and the current account deficit will both be difficult to control thereby
ensuring that pressures on the rupee to depreciate will persist.
Coupled with the growing trade deficit and current account deficit, the rupee is depreciating on
account of other factors as well.
These include the fall in the international value of the Euro on account of the sovereign debt
crisis and the double-dip recession in Europe; the drying-up of inflows from foreign institutional
investors; the slowing down of the rate of growth of the economy in general and industrial output
in particular; and stubbornly high inflation at home.

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WHY IS INDIAN CURRENCY VALUE LESS IN THE GLOBAL MARKET?


There are two ways in which value of a currency can be determined. One is when the currency is
following floating exchange rate system, i.e. supply demand of currency in global market
decides what would be the value of currency. In this case, central bank and government's action
will have little impact on the value of currency because apart from macro conditions of the
country, there are several other factors working here.
The other system is fixed exchange rate system, which as a matter of fact China was following
till 2005. Under this system, a country has control over its currency and central bank and
government can decide what value they want for their currency. Of course, global factors will
have an impact on the value of currency but actions taken by central bank and government will
have upper hand.
Now coming to the question in hand, India follows floating exchange rate system. Treat USD as
a good that can be bought using INR. Now using the concept of supply demand, when supply of
USD goes up in the Indian market, you can purchase USD at cheaper rate (hence INR
appreciates). However when supply goes down, USD becomes costlier and thus INR depreciates.
Value of Indian rupee is not in hand of RBI or government. It depends on the demand of rupee in
the international market. International trade primarily takes place in dollar terms. Not every
country accept Indian rupee as preferred currency for trade. As more and more people want
USD, it is natural that it will make USD costlier to but in INR terms, hence depreciating INR
more and more.
There are several other factors working on determining the value of currency but at the end of
the day it is simple equation of demand of USD and Indian rupee in international market. Every
other factor directly or indirectly affects demand and thus affecting currency value.
Rupee against the GBP
All of the above also exist. But they aren't much important to those concerned in trade.

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THE EFFECT OF CURRENCY FLACTUATION ON THE CURRENCY:Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm
for most major economies. The exchange rate of one currency versus the other is influenced by
numerous fundamental and technical factors. These include relative supply and demand of the
two currencies, economic performance, outlook for inflation, interest rate differentials, capital
flows, technical support and resistance levels, and so on. As these factors are generally in a state
of perpetual flux, currency values fluctuate from one moment to the next. But although a
currencys level is largely supposed to be determined by the underlying economy, the tables are
often turned, as huge movements in a currency can dictate the economys fortunes. In this
situation, a currency becomes the tail that wags the dog, in a manner of speaking.
Currency Effects are Far-Reaching
While the impact of a currencys gyrations on an economy is far-reaching, most people do not
pay particularly close attention to exchange rates because most of their business and transactions
are conducted in their domestic currency. For the typical consumer, exchange rates only come
into focus for occasional activities or transactions such as foreign travel, import payments or
overseas remittances.
A common fallacy that most people harbor is that a strong domestic currency is a good thing,
because it makes it cheaper to travel to Europe, for example, or to pay for an imported product.
In reality, though, an unduly strong currency can exert a significant drag on the underlying
economy over the long term, as entire industries are rendered uncompetitive and thousands of
jobs are lost. And while consumers may disdain a weaker domestic currency because it makes
cross-border shopping and overseas travel more expensive, a weak currency can actually result
in more economic benefits.
The value of the domestic currency in the foreign exchange market is an important instrument in
a central banks toolkit, as well as a key consideration when it sets monetary policy. Directly or
indirectly, therefore, currency levels affect a number of key economic variables. They may play a
role in the interest rate you pay on your mortgage, the returns on your investment portfolio, the
price of groceries in your local supermarket, and even your job prospects.
Currency Impact on the Economy
A currencys level has a direct impact on the following aspects of the economy:
Merchandise trade: This refers to a nations international trade, or its exports and imports. In
general terms, a weaker currency will stimulate exports and make imports more expensive,
thereby decreasing a nations trade deficit (or increasing surplus) over time.
A simple example will illustrate this concept. Assume you are a U.S. exporter who sold a million
widgets at $10 each to a buyer in Europe two years ago, when the exchange rate was EUR
1=1.25 USD. The cost to your European buyer was therefore EUR 8 per widget. Your buyer is
now negotiating a better price for a large order, and because the dollar has declined to 1.35 per
euro, you can afford to give the buyer a price break while still clearing at least $10 per widget.
Even if your new price is EUR 7.50, which amounts to a 6.25% discount from the previous

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price, your price in USD would be $10.13 at the current exchange rate. The depreciation in your
domestic currency is the primary reason why your export business has remained competitive in
international markets.
Conversely, a significantly stronger currency can reduce export competitiveness and make
imports cheaper, which can cause the trade deficit to widen further, eventually weakening the
currency in a self-adjusting mechanism. But before this happens, industry sectors that are highly
export-oriented can be decimated by an unduly strong currency.
Economic growth: The basic formula for an economys GDP is C + I + G + (X M) where:
C = Consumption or consumer spending, the biggest component of an economy
I = Capital investment by businesses and households
G = Government spending
(X M) = Exports minus imports, or net exports.
From this equation, it is clear that the higher the value of net exports, the higher a nations GDP.
As discussed earlier, net exports have an inverse correlation with the strength of the domestic
currency.
Capital flows: Foreign capital will tend to flow into countries that have strong governments,
dynamic economies and stable currencies. A nation needs to have a relatively stable currency to
attract investment capital from foreign investors. Otherwise, the prospect of exchange losses
inflicted by currency depreciation may deter overseas investors.
Capital flows can be classified into two main types foreign direct investment (FDI), in which
foreign investors take stakes in existing companies or build new facilities overseas; and foreign
portfolio investment, where foreign investors invest in overseas securities. FDI is a critical
source of funding for growing economies such as China and India, whose growth would be
constrained if capital was unavailable.
Governments greatly prefer FDI to foreign portfolio investments, since the latter are often akin
to hot money that can leave the country when the going gets tough. This phenomenon, referred
to as capital flight", can be sparked by any negative event, including an expected or anticipated
devaluation of the currency.
Inflation: A devalued currency can result in imported inflation for countries that are
substantial importers. A sudden decline of 20% in the domestic currency may result in imported
products costing 25% more since a 20% decline means a 25% increase to get back to the original
starting point.
Interest rates: As mentioned earlier, the exchange rate level is a key consideration for most
central banks when setting monetary policy. For example, former Bank of Canada Governor
Mark Carney said in a September 2012 speech that the bank takes the exchange rate of the
Canadian dollar into account in setting monetary policy. Carney said that the persistent strength
of the Canadian dollar was one of the reasons why Canadas monetary policy had been
exceptionally accommodative for so long.

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A strong domestic currency exerts a drag on the economy, achieving the same end result as
tighter monetary policy (i.e. higher interest rates). In addition, further tightening of monetary
policy at a time when the domestic currency is already unduly strong may exacerbate the
problem by attracting more hot money from foreign investors, who are seeking higher yielding
investments (which would further push up the domestic currency).

CONCLUSION
The volatile nature of capital inflow presents an alarming trend. Liberalizing capital control may
lead to huge dependence on foreign portfolio capital. Need is to channelize the capital flow. As
recognized in the recent Tara pore Committee Report, financial institutions ability to identify,
measure, and manage risk will also depend on the availability of instruments to manage risk, the
liquidity of financial markets and the quality of market infrastructure, and level of market
discipline. Key segments of the Indian capital markets remain, however, underdeveloped. The
term money market is limited and although there is a domestic yield curve for government
securities with maturities up to 30 years, its depth and liquidity are limited. The Govt. had
however stated that if the value of the rupee depreciates to an unreasonable level in the free
market operations, the R.B.I. will intervene and control it. This assurances certainly gives
credence to the earnestness and sincerity with which the full convertibility has been announced.
Currency moves can have a wide-ranging impact not just on a domestic economy, but also on the
global one. Investors can use such moves to their advantage by investing overseas or in U.S.
multinationals when the greenback is weak. Because currency moves can be a potent risk when
one has a large forex exposure, it may be best to hedge this risk through the many hedging
instruments available.

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BIBLIOGRAPHY AND WEB REFERENCES


BIBLIOGRAPHY:

INDIAN ECONOMY: RUDRA DUTT


DEVELOPMENT ECONOMY: S. K. MISHRA

WEB REFERENCES:
o https://www.quora.com/Why-is-Indian-currency-value-less-in-the-global-market
o https://www.quora.com/What-are-the-impacts-of-Rupee-becoming-an-internationalcurrency-on-Indian-and-international-markets
o http://www.slideshare.net/NehaChheda/currency-convertibility
o http://www.yourarticlelibrary.com/macro-economics/monetary-theories/changes-inthe-value-of-money-the-quantity-theory-of-money-and-its-variants/31087/
o