Still
the debate is on among the economists about the right exchange
rate policy that spurs the growth rate by augmenting exports
and curbing imports. Many countries have adopted different
policies during different periods. Specially, developing
countries like India and China have been struggling to adopt
an appropriate policy as this is one of the important indicators
to determine economic performance. Fluctuations in exchange
rates have an impact on inflation, interest rate and, in
turn, output growth. While depreciation of domestic currency
stimulates economic activity with increasing in the price
of foreign goods related to home goods, appreciation of
domestic currency makes exports costlier and hinders economic
growth. It severely affects exports and export-oriented
industries.
In
an era of globalization, no country is insulated from global
happenings. Hence, the exchange rate is a key determinant
in international finance. Many countries are following floating
exchange rate. China is following pegged exchange rate policy
(though managed) whereas India has been following managed
floating exchange rate. The law of demand and supply determines
the exchange rate in the foreign exchange market. Unlike
other markets, the foreign exchange market considers demand
and supply of both the domestic and the foreign currencies
to determine the exchange rate.
Looking
at the Figure 1, the Indian currency has been appreciating
mainly against US dollar whereas it remains almost constant
over a period of time against other currencies such as euro,
British pound and Japanese yen. It shows the strength of
the Indian currency against US dollar. In other words, the
US dollar is weakening against almost all the currencies
in the world because of the slowdown of the US economy in
the aftermath of the country's housing market crash. However,
the RBI has been trying to maintain a range above 40 rupees
per US dollar to make the Indian export industry competitive. |
