What does currency appreciation and deprecation mean?
Ever wondered why news about the Indian rupee "gaining" or "falling" against the US dollar keeps popping up, and what it means for your life? Let’s break it down—it’s simpler and much more relevant than you might think.
What is currency appreciation and depreciation?
Imagine your favorite local Kirana store. On some days, ₹100 buys you an extra treat—maybe an extra pack of biscuits. On other days, it barely covers the basics. That’s like currency exchange rates in action. This is a tiny illustration of what happens with a country’s currency on the international market.
Currency Appreciation: When the value of a country’s currency increases compared to another currency, the currency has appreciated. In simple terms, if 1 US dollar (USD) used to be equal to ₹80 and it moves to ₹75, you need fewer rupees to buy one dollar. The Indian rupee has appreciated.
Currency Depreciation: On the flip side, depreciation happens when the value of a country’s currency decreases compared to another. For example, if 1 USD was ₹75 and then becomes ₹82, it means the rupee has depreciated—now you need more rupees to get the same one dollar.
So, when the rupee’s value changes, it’s about how much power your money holds against other currencies. In both cases, we’re talking about the exchange rate, the price of one currency in terms of another.
Why more Rupees = Depreciation
You might ask, why does the rupee depreciate if it goes from ₹75 to ₹82 per dollar? Shouldn’t a bigger number mean appreciation?
This can be confusing at first. Let’s clarify with an example:
Suppose a year ago, you needed ₹75 to buy 1 US dollar.
Now, you need ₹82 to buy that same dollar.
Now you need more rupees to get the same amount of US dollar, and the value of the rupee has fallen. Essentially, the rupee has become weaker relative to the dollar. That’s why moving from ₹75 to ₹82 means depreciation.
In other words, depreciation means that our money is losing its power to buy other currencies. Conversely, appreciation means your currency is gaining strength and buying power.
Why do currencies appreciate or depreciate?
Currencies don’t move randomly—it’s a mix of supply, demand, and global dynamics. Here are some of the key factors are:
Supply and Demand: Just like any other commodity, the value of a currency depends on how much people want it and how much of it is there in the market. If the world is buying more Indian goods or services, they need rupees, which increases demand and strengthens the currency. If demand falls, the rupee depreciates.
Interest Rates: Central banks control interest rates which ultimately influences the currency. Higher rates in India attract foreign investors, who buy rupees to invest, causing appreciation.
Economic and Political Stability: Investors prefer stable economies. If the Indian economy is growing well and inflation is under control, investors may buy more rupees. Events like elections, policy changes, or global tensions can also influence currency exchange rates. Uncertainty may cause the rupee to depreciate, as investors may shy away from taking risks.
Effects of currency appreciation and depreciation
When the Rupee appreciates:
Imports become cheaper: A stronger rupee means buying goods from abroad becomes cheaper. If the rupee appreciates against the dollar, goods like oil, electronics, and foreign travel become more affordable.
Impact on you: Planning to buy an iPhone or go on a foreign holiday? Great news—you’ll spend less on foreign goods or travel.
Exporters lose out: Indian goods become costlier for global buyers, which could mean fewer jobs in export-heavy industries.
Impact on you: Sectors like textiles or IT may cut jobs if demand falls after rupee appreciation.
When the Rupee depreciates:
Exports get a boost: A weaker rupee makes Indian products cheaper for foreign buyers. Export-intensive sectors may see growth as their goods become more competitive globally. An Indian company earning in dollars can also convert them to more rupees when the rupee depreciates, boosting revenue.
Imports become costly: A weaker rupee makes importing goods like crude oil or electronics more expensive.
The connection between the Rupee and inflation
There’s a direct connection between currency depreciation and inflation. Here’s how it works:
Higher Import Costs: More expensive imported goods are particularly significant for items like crude oil. Since India imports over 80% of its oil, any increase in the price of crude oil translates directly into higher fuel prices. This impacts the entire economy.
Impact on Transport and Goods: As fuel costs rise, transportation becomes more expensive. This leads to an increase in the price of many goods since higher input costs get passed on to consumers. Whether it’s vegetables in the market or clothing items in a store, you end up paying more.
Ripple Effect on Inflation: When imports become costlier, the overall price level of goods and services also rises, leading to imported inflation. This means your money buys less actual goods, reducing your purchasing power.
The Vicious Cycle: The RBI may raise interest rates to control inflation, and higher interest rates can also affect growth by making borrowing costlier for businesses and individuals.
The role of RBI in managing the Rupee
The Reserve Bank of India (RBI) plays a significant role in managing the rupee's value through interventions in the currency market:
Buying and Selling:
When the rupee depreciates too much, the RBI might sell US dollars from its reserves and buy rupees. This increases the demand for rupees, boosting its value.
Conversely, if the rupee appreciates too much and hurts exports, the RBI might buy US dollars and sell rupees, helping to keep the rupee from getting too strong.
Managing Volatility:
Sudden swings in currency value can cause uncertainty, affecting trade, investment, and consumer confidence. The RBI does not necessarily try to keep the rupee at a fixed level. Instead, it aims to manage volatility—making sure the rupee doesn’t move too quickly in either direction.
Interest Rate Adjustments:
The RBI can also adjust interest rates to influence currency value. If inflation is high or if the rupee is depreciating too much, the RBI may increase interest rates to attract more foreign capital.
Foreign Exchange Reserves:
The RBI maintains a reserve of foreign currencies, primarily US dollars. This reserve acts as a tool to stabilize the currency in times of major fluctuations, ensuring that India has a buffer against external shocks.
The role of foreign exchange reserves
Stabilizing the Currency: Foreign exchange reserves allow the RBI to intervene in the currency market whenever there is excess volatility. This is like having a savings account to deal with financial emergencies—when the market acts unpredictably, these reserves help maintain stability.
Instilling Confidence: Having ample reserves shows the world that India is financially stable. It gives confidence to investors that the country can handle external shocks, making it more attractive for foreign investments.
Some more real-world examples
Household Spending: Imagine that you want to buy a smartphone that costs $1,000. If the exchange rate is ₹75 per dollar, it will cost ₹75,000. But if the rupee depreciates to ₹82 per dollar, the same phone will cost ₹82,000.
Student and Traveler Perspective: If you’re planning to study abroad, a weaker rupee means that your tuition fees will be more expensive. For example, if tuition is $20,000, it used to cost ₹15,00,000 at ₹75 per dollar. Now, at ₹82 per dollar, it will cost ₹16,40,000. Similarly, foreign travel gets pricier when the rupee depreciates.
Glossary box
Exchange Rate: The price of one currency in terms of another. For example, ₹75 per dollar is the exchange rate.
Foreign Exchange Reserves: Holdings of currencies like the US dollar by the central bank, used to stabilize the national currency.
Appreciation vs. Depreciation: Appreciation means the currency becomes stronger compared to others, while depreciation means it becomes weaker.
Inflation: The rate at which the general price of goods and services is rising, decreasing purchasing power.
Interest Rate Parity: The relationship between interest rates and currency exchange rates.
The bottom line
Currency appreciation and depreciation aren’t just jargon or buzzwords—they affect your daily life in many ways. When the rupee strengthens, imports get cheaper, but exporters feel the pinch. When it weakens, exports get a boost, but you may feel it in your pocket through higher costs of imported goods.
Do you have any questions or want to learn more about finance and economics in a simplified way? Feel free to ask your queries in the comments.
1. Is RBI regularisation the only way to appreciate or depreciate our currency?
2. What if slowly and gradually 1Rs becomes 1USD one day? Only sudden fluctuations are bad right?