There are many reasons behind the increase and decrease in the value of currency.
The value of currency generally means the price of one currency against another currency. Like today 1 USD = 90 INR, so it means that to buy 1 dollar one has to pay 90 rupees. When it is said that the rupee has strengthened, it means that one is getting 1 dollar by paying less rupees (like 90 to 88). And rupee weakening means getting 1 dollar by paying more rupees (like 90 to 84).
The value of currency does not change with the press of a button. It changes daily due to the combined effect of demand, supply and economic condition of the country, interest rates, trade, investment, confidence and policies.
How does the value of currency increase?
When the demand for a country’s currency increases or its supply decreases, its value starts strengthening. There can be many reasons behind the increase in demand – increase in investment in the country, increase in exports, attractive interest rates, inflation under control, or less risk.
1- Increase in exports
Suppose Indian medicines, IT services or auto parts start selling more in the world. Buyers from abroad increase the demand for INR to make payments or give dollars to Indian companies, which they convert into rupees. This increases the demand for rupee and it may become stronger.
US dollar.
2- Increase in foreign investment
If foreign companies set up factories in India or foreign funds increase investment in Indian shares/bonds, then they will have to convert their dollars/euros into rupees. This increases the demand for rupee in the market and the currency may become stronger.
3- Increase in interest rate and benefit of the difference
If the interest rates of a country are attractive compared to other countries, then investors will want to invest money in bonds/deposits there. They will have to buy the currency of that country. For example, if returns in India look comparatively better, demand for the rupee may increase and the value may go up.
4- Bringing inflation under control
In a country where inflation is low, the purchasing power of the currency is better. The market feels that this currency will remain more stable over time. As a result, confidence in that currency increases, demand increases, and the value may strengthen.
5- Reduction in current account/trade deficit
If the country’s imports decrease or exports increase, then more dollars will not go out from abroad. That means dependence on foreign currency will be less. This reduces pressure on the local currency, and it may become stronger. Example: If the oil import bill decreases, the pressure on INR may reduce.
Swiss Franc (CHF), the currency of Switzerland, is considered the safest currency.
How does the value of currency decrease?
When demand for a currency decreases or supply increases, it weakens. Sometimes fear/uncertainty also forces investors to withdraw money, causing the currency to fall. Let us understand this from the five examples given below.
1-Imports increasing rapidly
Suppose a country has to import large quantities of oil, gas, electronics or food items. The country has to buy dollars/euros to pay for imports, which means the demand for foreign currency increases and the local currency comes under pressure – it may weaken.
Indian currency (INR)
2- Exit of foreign investment
If foreign investors withdraw money by selling shares/bonds, they will have to sell rupees and buy dollars. Due to this, the supply of rupees increases and the demand decreases. Result: Rupee may fall. This often occurs in global fears, recessions, or negative news about a country.
3-inflation increase
If domestic inflation increases too much, the real value of that currency decreases. The market feels that the purchasing power of assets held in that currency will decrease, so people shift to other currencies. This reduces the demand for the local currency and the value may fall.
4-Policy uncertainty or political risk
When policies in a country change frequently, rules are unclear, or political instability increases, investors hold or withdraw money considering the risk. This may weaken the currency. The issue here is trust. The value of currency also depends on confidence.
Currency of Greenland.
5- Interest rate being low or returns seem less attractive.
If the interest rates of one country decrease or those of other countries increase, then investors see less benefit in investing there. They go to places with better returns. Due to this, the local currency is sold and the value may fall.
dollar expensive vs rupee strong
- If 1 USD/INR goes from 90 to 95, then the dollar becomes expensive and the rupee becomes weak.
- If USD/INR comes from 90 to 85, then the dollar becomes cheaper and the rupee becomes stronger.
impact on common man
- Rupee strong: Imports cheap (oil, mobile, foreign education), foreign travel cheap; But there may be pressure on exporters’ earnings.
- Rupee weak: Imports expensive (inflation may increase), foreign studies/travel expensive; But exporters may benefit as the price of their goods becomes competitive abroad.
In this way we can understand that the value of currency is not a mysterious thing. It is mainly a game of demand and supply, which is constantly influenced by trade, investment, interest rates, inflation, confidence and global events. When a country’s economy looks strong and world confidence increases, the currency may strengthen; And when deficit, inflation, uncertainty or capital outflows increase, the currency comes under pressure.
Also read: Neither dollar, nor riyal, why is Switzerland’s currency the safest? Know 5 big reasons