Today, Indian currency is floating and is quite vulnerable to both internal and external factors

affecting the exchange rate either directly or indirectly. We will analyse the exchange rate

between Indian Rupee and US Dollars which is affected by the monetary policies and other

external factors which are really not in control of government. Hence, exchange rate in a

country is highly affected by fiscal policies, monetary policies and economic conditions in

rest of the world as well especially when it is a case of an open economy. The analysis of the

Dollar-Rupee was done for the period 2005 January to December 2010. As we know, during

this period, the United States of America was in one of its worst recessions. However, even if

India was not in recession during that time period but still it was facing a growth rate of less

than 8%. There was slow growth in exports due to weak demand of its goods in other

developed countries basically due to recessionary situation and also due to the appreciation of

the Rupee which made exports from India expensive relative to other developing economies

whose currencies were weaker. The following historical analysis shows the historical trend of

exchange rate between USD INR from 2005-2010. (Forecast-Chart, 2015)

It has been fund that in 2005, the exchange rate was INR44.01 for 1 USD and it increased to

INR 45.17 for 1USD. Hence, USD appreciated showing rise in the value of USD and fall in

the value of the Indian Rupees. It resulted into rise in the exports from India due to cheaper

products in India in terms of USD. The basic reason behind the rupee depreciation is the slow

growth in the Indian Economy and less demand of Indian Rupee in the foreign market. It

decreases the value of Indian rupee during that time period in terms of USD. From 2006 to

2007, the Indian Rupee appreciated against USD and the exchange rate rose to INR 41.20

against 1USD in 2007. The primary reason being recessionary conditions in United States

during that time period which reduces the demand for US Dollars and hence the value of US

Dollars depreciated. It resulted into fall in the exports from India to other countries because

the goods from India became expensive. Over the time situation became better in U.S and
again Rupee started depreciated against the USD and it again rose to Rs.43.41 per USD in

2008. The USD-INR exchange rate is an important indicator of investor sentiment and can

significantly impact not only the fortunes of individual firms and sectors but also the

government. Over the time, the exchange rate jumped to all time high with Rs.48.32 per USD

in 2009 and then again depreciated in 2010 to INR 45.62 per USD. While this exchange rate

has been very stable overall for the last five years (44.86 on April 24th, 2006 and 44.34 on

April 15th, 2011), there have been periods of significant volatility. For example, USD-INR

moved from 40 to 51.50 from March 2008 to March 2009. During the past 12 months, it has

traded in a relatively narrow range, between 47.33 and 43.99. (Reddy, 2012)We believe there

is a significant downside risk to USD-INR exchange rate and this paper will explore some of

the risk factors behind this:

Inflation in India remains always high and the CPI figure has increased by 10.88% in 2009

and by 13.19% in 2010. That is why; the central bank takes monetary policy actions in order

to combat the inflation. It has indirect impact on the value of the Indian currency and its value

decreases.

Being a developing economy, India is one of the fastest growing economy and attracts

many foreign investors but during 2007-2010, it faced a declining trend in Foreign Direct

Investments (FDI) making it the only BRIC country where this happened. It leads to problem

in Indian currency as compared to US Dollars because of less demand of Indian currency.

Foreign Institutional Investment (FII), which provides short-term portfolio investment money

inflows, has been buoyant, but these funds are volatile by nature and are prone to flight risk

at the first signs of trouble, something that happened during the financial crisis. (Krugman,

1991)
 There are high corruption scandal rates in India which leads to negative perception of

governance deficit in India and it has negative impact over the business confidence in the

country. Along with it, there is high regulatory and tax uncertainty which will deter the entry

of many foreign investors. For example, several global firms who invested in Indias telecom

sector have had to write off billions of dollars of their investments.

Another major source of foreign currency inflows to India is remittances; India received

USD 55 billion in remittances during 2010. This money limits the countrys current account

deficit. The Middle East accounts for a major share of this inflow and the current turmoil in

the region may negatively influence it as Indians abroad leave the region due to security

concerns. Remittances from countries like Saudi Arabia and UAE, where the strife has not

spread, could also experience a decline as unemployment in these nation rises.

Since the financial situation of the Indian government is not good and there is deficit in the

funds at both central and the state level, therefore there were high oil prices in the country

during that time period also. It becomes a major issue for Indian economy because India

imports about 70% of its oil needs and that is why there is always high demand of USD

which leads to rise in the value of USD relative to Indian Rupees. That is, the exchange rate

shows the rising trend.

India does not have much funds in the economy which shows the current deficit of about

3% during 2008-2010 which was almost same as during the 1990s crisis. However, deficit in

the current account is not always bad because it make prospective for long term productive

assets. But the problem with India is lack of savings both in the public as well as in the

private sector. This does not bode well for the economy. Also, the contribution of Indias

rising import bill and remittances threat further aggravates the problem of deficit in the
country creating a pressure over the Indian Rupee with respect to USD.

Since, U.S is on the path of economic recovery, therefore its likely effect on Indian Rupees

is it will draw more funds at the expense of developing economies like India. It can be

reflected in FDI inflows which were increased by 43% in 2010. (Seyed Hashem Kamyab,

2013)

Works Cited
Forecast-Chart. (2015). Indian Rupee Currency Exchange Rate Forecast. Retrieved from
forecastchart.com: http://www.forecast-chart.com/usd-indian-rupee.html

Krugman. (1991). Target Zones and Exchange Rate Dynamics. Quarterly Journal of Economics.

Reddy, B. R. (2012). Expectations and Exchange rate Dynamics: A Theoretical Analysis. Journal of
Political Economy.

Seyed Hashem Kamyab, b. A. (2013). Exchange Rate Analysis for U.S.A Dollars and Indian Rupees
(2005-2010) . Online International Interdisciplinary Research Journal,.