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Exchange Rate
eks-chaynj rayt
An Exchange Rate shows how much of one currency is needed to buy another currency.
For example, if the exchange rate is:
₹84 per US dollar
then US$1 = ₹84.
If someone wants to exchange US$1,000 into Indian rupees at this rate, the approximate value would be:
US$1,000 × ₹84 = ₹84,000
Exchange rates can change because currencies are traded continuously in the foreign exchange market.
Important factors affecting exchange rates include:
- Interest rates
- Inflation
- Economic growth
- International trade
- Foreign investment flows
- Political and economic stability
- Central bank actions
- Demand and supply for currencies
When a currency becomes more valuable relative to another currency, it is said to appreciate.
For example, if the rupee moves from ₹84 per US dollar to ₹80 per US dollar, fewer rupees are needed to buy one dollar, meaning the rupee has appreciated against the dollar.
If the rate moves from ₹84 to ₹88 per dollar, more rupees are required to buy one dollar, meaning the rupee has depreciated.
Exchange-rate movements can affect:
- Import prices
- Export competitiveness
- Foreign travel costs
- Overseas education expenses
- International investments
- Inflation
- Company profits
Exchange Rates may be determined largely by market forces or managed to varying degrees by a country’s central bank or government.
A Weaker Rupee Raises Import Costs
An Indian company imports machinery costing US$100,000.
When the exchange rate is ₹82 per US dollar, the machinery costs:
US$100,000 × ₹82 = ₹82 lakh
Later, the rupee depreciates to ₹86 per US dollar.
The same machinery would then cost:
US$100,000 × ₹86 = ₹86 lakh
The company must now pay ₹4 lakh more even though the dollar price of the machinery has not changed.
This shows how exchange-rate movements can directly affect the cost of imports and business expenses.
1971 – Collapse of Bretton Woods Fixed Rate System
When it happened: August 1971
How it happened: US delinked dollar from gold; major currencies shifted to floating rates.
1991 – India’s Two-Step Devaluation
When it happened: July 1991
How it happened: INR was devalued by ~20% to handle balance of payments crisis.
2016 – Introduction of RBI’s New Forex Framework
When it happened: Post-2016
How it happened: RBI shifted to a market-driven approach with limited intervention to reduce volatility.
Definition
An Exchange Rate shows how much of one currency is needed to buy another currency.
For example, if the exchange rate is:
₹84 per US dollar
then US$1 = ₹84.
If someone wants to exchange US$1,000 into Indian rupees at this rate, the approximate value would be:
US$1,000 × ₹84 = ₹84,000
Exchange rates can change because currencies are traded continuously in the foreign exchange market.
Important factors affecting exchange rates include:
- Interest rates
- Inflation
- Economic growth
- International trade
- Foreign investment flows
- Political and economic stability
- Central bank actions
- Demand and supply for currencies
When a currency becomes more valuable relative to another currency, it is said to appreciate.
For example, if the rupee moves from ₹84 per US dollar to ₹80 per US dollar, fewer rupees are needed to buy one dollar, meaning the rupee has appreciated against the dollar.
If the rate moves from ₹84 to ₹88 per dollar, more rupees are required to buy one dollar, meaning the rupee has depreciated.
Exchange-rate movements can affect:
- Import prices
- Export competitiveness
- Foreign travel costs
- Overseas education expenses
- International investments
- Inflation
- Company profits
Exchange Rates may be determined largely by market forces or managed to varying degrees by a country’s central bank or government.
Case Study
A Weaker Rupee Raises Import Costs
An Indian company imports machinery costing US$100,000.
When the exchange rate is ₹82 per US dollar, the machinery costs:
US$100,000 × ₹82 = ₹82 lakh
Later, the rupee depreciates to ₹86 per US dollar.
The same machinery would then cost:
US$100,000 × ₹86 = ₹86 lakh
The company must now pay ₹4 lakh more even though the dollar price of the machinery has not changed.
This shows how exchange-rate movements can directly affect the cost of imports and business expenses.
Historical Reference
1971 – Collapse of Bretton Woods Fixed Rate System
When it happened: August 1971
How it happened: US delinked dollar from gold; major currencies shifted to floating rates.
1991 – India’s Two-Step Devaluation
When it happened: July 1991
How it happened: INR was devalued by ~20% to handle balance of payments crisis.
2016 – Introduction of RBI’s New Forex Framework
When it happened: Post-2016
How it happened: RBI shifted to a market-driven approach with limited intervention to reduce volatility.