If yes, how will it affect our lives? If the values of both these currencies are the same? It’s an interesting ongoing game with the US Dollar and Indian Rupee. There was a time when our politicians used to make promises about this. “If you vote for us, we’ll increase Rupee’s value.” “When we’ll come into power, ₹40 will be equal to $1.” Nothing of the sort happened. Rupee’s value kept on getting weaker. To the extent that now, $1 has almost touched ₹75. This isn’t because of the last few years only. Ever since our country got independent, Rupee’s value has been deteriorating continuously.
Why did it happen? And what will happen if ₹1 becomes equal to $1?
Come let’s try to find out all about it in today’s educational video. Let’s start with the absolute basic. The conversion rate between two currencies is known as the Exchange Rate. There are three types of Exchange Rates mainly. Fixed Exchange Rate means that the government controls the exchange rate or the conversion rate of the currency. Floating Exchange Rate means that the exchange rate of the currency keeps on changing based on the supply and demand in the market.
How does it change exactly? Let’s see an example.
Suppose you and I live alone on two islands. We grow different things on our island. You grow tomatoes on your island and I grow onions on mine. Both of us create our currencies. You make Tomato coin your currency. You create 100 coins, so you have 100 Tomato coins. I make Onion coin my currency. And I have 100 Onion coins. We decide that the conversion rate or the exchange rate of our currencies would be 1:1. So 100 Tomato coins should be equal to 100 Onion coins. A few months pass. You work very hard and you grow 200 tomatoes instead of 100. But I didn’t work as hard and manage to grow only 100 onions. Suddenly, the value of your currency has increased because you still have only 100 Tomato coins. The money remained the same. So, for you, the value of one coin has become 2 tomatoes. If you want to exchange it with me, the value of 1 Tomato coin has become equal to 2 Onion coins.
Did you understand how it works? Suppose you grow 1,000 tomatoes instead of 100, and you’ve also learned to make pizza with the tomatoes, and a third person passes by our islands. And he sees that on one island he can get onions only. And on the other, he can get pizza. So, he will prefer to stay on your island. Preferring to eat pizza. So, you tell him that if he wants to buy your pizza, it can be bought with your currency only. So, he’ll buy your Tomato coins first which will enable him to buy your pizza. If he buys your Tomato coin instead of my Onion coin, it will drive up the value of Tomato coins even more. He’ll think that when he’d be back for more pizza, he’d need more Tomato coins. So, it’d be better to buy some Tomato coins beforehand. He’ll go to a fourth person and tell them that they can get pizza from your island for Tomato coins. And the fourth person will also like to buy it, so they’ll buy some Tomato coins too. When everyone would want to buy it, the demand for the Tomato coins will rise. And this will push its value as well. Like it normally happens with the other things in the market. So, in this way friends, with the fluctuations in the Supply and Demand, the Value of the Currencies fluctuates as well. Today, everyone wants to buy US dollars. That’s why its value is so high. This is one of the many reasons. There are other reasons behind the fluctuations of Supply and Demand as well. The third type of Exchange Rate is the Managed Exchange Rate.
Some countries say that they will allow the fluctuations in the value of their currencies based on the changing supply and demand in the market.
But only to a limit. They’ll set a limit that the value of the currency cannot fluctuate more than, say, 5-10%. This is known as Managed Exchange Rate. In reality, there are many reasons for the fluctuations in the value of the currencies. Unemployment rates. Inflation rate. The GDP of a country. The manufacturing activities in a country. The types of products produced in a country. How is the export and import of the country? All of these things affect the Currency Exchange Rate. It is interesting to know friends that most of the countries had Fixed Exchange Rates before the 1970s. Even in India. When our country got independence in 1947, then, $1 was equal to ₹1. Yup, that’s right. It was a time when the values of the dollar and rupee were truly equal. But why did Rupee get so devalued after it? Around the 1950s, the government spent a lot on the development of the country. But it didn’t earn as much.
So, the government took several loans from other countries. And since the government didn’t have enough money to repay the loans, the government devalued the rupee.
How does this work?
Suppose I take a loan of ₹100 from you and spend all of it. I have ₹25 left with me only. So how will I repay the loan when I don’t have ₹100? But remember this, I can control Rupee. I can control the Value of the Rupee because I’m the Indian Government. So, what I do is, I start printing more money. If I print more money, its supply will increase. And if the supply of the money increases the value of the currency will fall. I print so much money that ₹10 now has the same value ₹1 had then. It’s been devalued so much. So, the ₹25 that I have become ₹250 overnight. And then I repay ₹100 to you out of the ₹250. Effectively paying off the loan. This is how the devaluation of a currency works. By the time we reached the 1960s and 1970s, there had been several wars, Indo-Pakistan war, Indo-China war. Our country had to suffer heavy losses again. Had to take loans from other countries. The country needed foreign investment to boost the economy. And foreign investment would’ve come only if there were incentives, such as cheap products, for investing in the country. Because of this, the government changed the exchange rate again wherein $1 was around ₹7. When a government reduces the value of a currency on its own, for any reason, by increasing the supply, it is known as Devaluation. And when the value of a currency falls because of external factors it is known as Depreciation. Often people get confused between Depreciation and Devaluation. They are completely different. Even though their conclusion is the same. In 1973, there was a huge oil crisis in the world. Because of this the oil, that India used to import from other countries, got expensive, driving the value of Indian currency further down. After this, the Prime Minister of the country Indira Gandhi was assassinated. And the confidence of the foreigners in the Indian economy shattered. So, by the time, we got to 1990, $1 was equal to ₹17.50. After this, the biggest shock to the Indian economy was in 1991. A heavy fiscal deficit was seen. The country went through Economic Liberalization. And Rupee was kept on Floating Exchange Rate, till 1994. The changes in the demand and supply in the market led to a change in the value of the rupee. ‘Change’ would be incorrect, Rupee’s value kept getting devalued. There are many factors. I told you about the main reasons only. There are also factors of the strengthening of the US Dollar. How the other currencies of the world were changing. It’s all relative. The reduction in the value of a currency as compared to the other. When I say that the Rupee’s value went down the value of the US Dollar kept increasing simultaneously. There are different reasons behind it too. Now, let’s talk about what would happen if ₹1 were equal to $1 now? It can’t happen but let’s imagine a hypothetical situation. What would’ve happened if it were true? Firstly, it would’ve been very easy for you to vacation abroad. Whenever you would’ve gone to Europe or the US for a vacation, you would’ve had to spend a lot of money. Instead of Lakes of rupees, it would’ve cost you in the thousands even for luxurious vacations. The luxury goods that you would’ve bought from other countries like an iPhone, iPhone would’ve cost you only ₹600. It would’ve been that cheap to buy an iPhone. And import prices would’ve been very cheap too. Petrol could’ve been purchased by the country for a fraction of the cost.
After everything I’ve told you till now, you might be thinking that our lives be so much better if ₹1 were equal to $1. Everything would be cheaper. That would be a good thing, right? But now comes the reality check. Friends, if ₹1 does become equal to $1, it would also mean that no foreign investment will come to India. Or a negligible amount of foreign investment might come in. Because the foreign companies that want to invest in India, do so because they get cheap labor in India. It is much cheaper to employ people in India as compared to employing people in western countries. So if the companies see that they need to pay $35,000 to employ and they will need to pay the same salary for employing an Indian.
what will be the incentive to invest in India?
They’ll employ people from their own country. Or will go to another country where they could find cheap labor. In India, approx 60% of the GDP contribution is from the Services sector. And the service sector employs 32% of Indians. And what exactly is the Service sector? It is formed mainly of the IT sector. The foreign companies that have offices in India or have set up call centers and employed so many people in the IT sector. It will become very expensive for these companies to maintain these if $1 becomes equal to ₹1. The salary of the Indian employees will become too expensive for them to bear. They will shut down their offices. And will leave the country. All the people that are employed in the IT sector will suddenly be unemployed. This will lead to large-scale unemployment in the country. As well as an economic crisis. Something similar to this happened in the 2008 economic crisis. There was a global recession. Many American companies went under at that time. Because of their bankruptcy, the IT offices that they had in India had to be closed as well. And the Indian IT sector suffered a lot. This situation leads to a very important question. Is it truly beneficial for the country to make Rupee stronger? Or will a weaker Rupee be more beneficial for the people in the country?
What will be beneficial for the country?
A strong rupee? Or a weak rupee? It is not easy to answer this, friends. Normally, export-oriented countries prefer to keep their currencies week. They are the countries that send a lot of goods to other countries, countries like China, China manufactures a lot. China will prefer to have a weak currency because it will be cheaper for other countries to buy Chinese goods. And since it is cheaper, they would prefer to buy from China. That’s why for countries like China, a weak currency is a good thing. On the other hand, the import-oriented countries will prefer to have a strong currency. Because they buy goods from other countries. If their currency is strong it would be cheaper for them to buy from other countries. Currently, India imports a lot of oil from Middle Eastern countries. Had the Indian currency been stronger it would’ve been a lot cheaper for India to import the oil. What is India’s stance? Is India export-oriented or import-oriented? In truth, India imports more goods from other countries as compared to its exports. So, India is an Import-Oriented country. But India is in a unique position. The things that India exports are the ones to bring in the majority of the economic growth and the majority of the employment to the people. That is the service sector, our IT sector. That’s why, for economic growth, India prefers that the Rupee remains weak. Some economists argue that India should further devalue Rupee. So that the economic growth in the service sector could grow even more. If we get exponential growth in the service sector, our economic growth will rise. And only then will we be able to achieve the $5 trillion economies. The Rupee has to be weaker for that to happen. But this is a controversial topic. You’d see economists are supporting the notion on both sides. Some economists believe that the Rupee should be devalued further. Some economists believe that devaluing the rupee will lead to instability and so it shouldn’t be done. So, what should be done then?
What are the solutions here?
There are a few things, friends, on which the majority of experts agree.That we need to address the root causes hiding behind the Currency Exchange Rate.Like, primarily, India should reduce its import dependency.
For things like oil. India imports a lot of oil from other countries. It is very expensive and increases the expenditures by a lot.
How can it be avoided?
By focusing on renewable energy. Alternative fuels should be promoted and strong public transport infrastructure should be built so that there are fewer vehicles on the roads. The demand for petrol and diesel will fall. And the need to import oil will reduce. Secondly, the industries in India should be promoted. And it should happen in a broad variety of sectors. So that India’s export dependency on the IT sector is reduced. The cheap labor that is in India should not be the only thing that India can export. More things need to come up wherein India can add value. In the global supply chain. And India should develop expertise in several things. Thirdly, we should always remember that economic growth and development in the country have a negligible connection with the Currency Exchange Rate. Several politicians link them solely because of nationalism. Saying that, “our country will be stronger if our currency is strong.” But it isn’t so in reality. There are a few countries whose currencies are strong and they are developed countries like the European countries or America. America’s currency is strong and America is a developed country. But there are also countries like Japan that have a very weak currency.
Compare the Japanese currency with the Indian Rupee.
Its currency is weaker than Indian Rupee. But does that mean that Japan is not a developed country? Not, Japan is a very highly developed country. It is much more developed than India. Even though it has a weaker currency. It shows us that the currency’s strength is not a significant indicator of the development of the country. And finally, the fourth is a very obvious fact but many people forget about it. The value of the currency that is on the Currency Exchange Board does not matter much. It can be changed. So, the value of the currency should be compared with its value in the past.
What do I mean?
I mean that if the government says today that tomorrow onward ₹1 will be equal to ₹100. That from tomorrow, ₹1 will have the same purchasing power as ₹100 does now. In theory, our currency will become strong immediately. The value of our currency will become stronger than the US Dollar. But what will that mean? It will mean that the salary of the people will decrease proportionately. The cost of goods will also be slashed proportionately. I’m talking in terms of numbers. The actual value will not change, but the amount of salary on paper will be decreased by a factor of 100. The cost of goods will also fall by a factor of 100. So overall, there will be no effect of doing this. This is why currencies are always seen relatively. And in reality, several other factors influence the original value of the currency. I talked about which at the beginning of the video. When I gave the example of the island. I hope you found this article informative, friends. Comment below if you want to see more such articles. Which topics would you prefer to see in next article?
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