A crystal ball gaze at where the Indian rupee could be headed

Why Rupee fluctuates vis-a-vis other currencies? 

Reason for fluctuation in rupee: 

1. India’s foreign exchange reserves.   
   • For example, an increase in forex reserves is an indication that India is getting in more dollars than India’s spending. This will push India’s current and capital accounts into surplus zone and impact the exchange rates.  
2. Daily fluctuations caused by foreign portfolio investment (FPI) flows. 
3. External factor of the dollar, and other currencies 
   • The dollar is driven by the US economy as well as its Federal Reserve’s policies. 
   • For example, the Fed’s recent indication that it would raise its policy rate of funds in the years ahead. This might push global investors back to US. This will strengthen the dollar and weaken the rupee. 
4. The RBI will intervene for buying or selling dollars to stabilize the Indian currency. This also affect exchange rate. 
5. The concept of the real effective exchange rate (REER) 

What is real effective exchange rate (REER)? 

• It is the weighted average of a country’s currency in relation to an index or basket of other major currencies. The weights are determined by comparing the relative trade balance of a country’s currency against that of each country in the index.  
• An increase in a nation’s REER is an indication that its exports are becoming more expensive and its imports are becoming cheaper. It is losing its trade competitiveness. 

Definitions: Foreign exchange reserves, FPI, real effective exchange rate 

Source: Livemint