USD-INR – Is It An Excessively Volatile Currency Pair?

Introduction

Foreign Exchange market has grown immensely over the past few years. Foreign exchange becomes more important when import and export business takes place and the need arises for currency conversions. So here let us understand about one such currency pair i.e. USD-INR and how important it is foreign exchange market.

Currency Pairs

Forex market trading happens at International Level that allows trading in different currencies like INR, EUR, JPY, and GBP. For India trading is possible only through INR. The trading can be done through BSE, NSE, or MCX-SX. USD/INR is among the popular currency pairs. Each currency pairs have two currencies in them. One is known as base currency and the other is known as quotation currency. In case of USD /INR, USD is the base while INR is the quotation and value of one USD is 82.85 INR.

There are many other currency pairs apart from USD/INR which are as follows

USD/CAD
EUR/USD
GBP/USD
NZD/USD
AUD/USD
USD/CHF
EUR/JPY

Where

USD = US Dollars

EUR = European Dollars

GBP = Great Britain Pound

NZD = New Zealand Dollar

AUD = Australian Dollar

JPY = Japanese Yen

CAD= Canadian Dollars

What are the Factors that Impact USD-INR Currency Pair Prices?

Inflation Rates

Market Inflation has a major impact on the foreign currency exchange rates. A country which has lower inflation rate than other will see an appreciation in its value of its currency. Where the inflation is low price rise is also low. Country whose inflation is high always sees a depreciation in its value of currency.

Interest Rates

Changes in Interest Rates effects the currency value and dollar exchange rate. Forex rates, interest rates and inflation all the three terms have correlation with each other. Increase in the interest rates causes currency to appreciate as higher rate of interest provides higher returns to the foreign lenders and thereby increasing the foreign capital and this leads to rise in exchange rates.

Country’s Current Account and Balance of Payment

Current Account reflects the balance of trade and earnings on foreign investment. It includes total number of transactions such as exports, imports, debt etc. A deficit in current account occurs when there are huge amount of imports than the exports carried out. Balance of Payment fluctuates exchange rate of domestic currencies.

Government Debts

Government Debt is national debt which is owned by the central government. A country where there are large amount of Government Debts the possibility of acquiring foreign capital is very low. There is high chances of inflation too. Foreign investors will sell their bonds in the open market if there is government debts, As a result decline on value of exchange rates follows.

Political Stability and Performance

Political Stability and Economic Performance effects the currency strength of the country. Where there are political disrupts and turmoil, foreign investors become reluctant to invest in such country. A country with sound financial trading policy experience more stability in their currency value but where there is political instability currency value also depreciates simultaneously.

Terms of Trade

A trade deficit also can cause exchange rates to fluctuate. Terms of Trade is related to ratio of export prices to that of import prices. A country’s terms of trade improves if the exports increase at a greater level than that of the imports. This results in higher revenue due to which demand for currency increases as well as currency value appreciates.

Recession

Recession means a situation where there is economic decline and trade, industrial activities are reduced followed by fall in GDP. Now when the country is in such a crisis there will be obvious impacts on countries currency. Foreign capital inflow reduces as foreign players avoid investing when the economy is under crisis.

Speculation

Speculation means believing in something without any strong evidence. In stock market, investors speculate about gaining profit without having strong evidence about it. Due to this speculation investors demand more with the expectation of returns. This appreciates currency value and exchange rates as well.

What is PIP?

PIP means Point in Percentage. It is the basic unit in foreign exchange trading. When references rates are stated by the apex bank i.e. the Reserve Bank of India the quote is till the 4^th Decimal point. Even a small difference in the fourth point can make a huge difference in foreign reserves. All over the world, the currency is quoted till the 4^th Decimal Point. This is called PIP. It is fixed at 0.0025 for USD/INR. It is also known as tick size. The lot size is fixed to USD 1000.

Trading USD/INR in Derivative Market

Earlier Indian Businesses could hedge their currency exposure with the help of banks by buying forward contracts in the forward market. Currency Derivatives have bought in a major change. It is now much easy to cover currency risk by opening a trading account with the broker. These currency futures and currency options can be bought and sold from the comfort of your home through the internet trading platform. Since India’s trade and commerce continues to be denominated in USD, the USD/INR pair has become popular pair.

Benefits of Opting for the USD/INR pair in the currency derivative market

USD/INR pair can be opted by resident Indians or NRI, even if there is no underlying but only up to certain limit. This is not like the forward market where you can hedge an underlying currency exposure. The bid ask spreads are as low as 0.0025 and that substantially reduces the risk of liquidity while trading. The USD-INR pair is based on the transparent market mechanism. This makes it more preferable for individual traders who have limited access to information and insights

How Global factors Influence the Value of Rupee?

Capital flows; both FPI and FDI

Foreign direct investment (FDI) is known as stable money while FPI flows are called hot money. They are called so because FPI flows are portfolio flows and can reverse direction at short notice. The equity sell off in the year 2008 and debt sell off by FPI in the year 2013, in both these situations, the INR value depreciated sharply. Over the last 2 years, India has emerged as the largest annual recipient of FDI investments and that has given a higher degree of stability to the INR. More selling often increases more demand for dollars and thus rupee becomes weaker. Capital outflows have major impact on the rupee as FPI wants their money invested to be safe.

Fed Rates

US Bonds are based on the Fed rates. When the Fed Rates are high you can expect higher yields on US Bonds. Global investors willing to make money can grab this great opportunity.

The investors feel that US Bonds is safer than risking oneself. When Fed Rate increases Rupee weakens.

Currency Wars

Currency war is a situation where countries sometimes devalue their currencies hoping to make debt payment easier and also to stimulate the economy. By lowering the value of the currency exports become cheaper than those of other countries and helps in boosting employment. The situation where one country devalues its currency and other follow the suit to boost their economies by shifting the balance of trade it is known as currency war. The rupee value is measured in terms of US$. Hence it is default exposed to external factors.

What are the Indicators of USD-INR Pair?

Dollar Index

It tracks the dollar movement against 6 major leading currencies in the world. It just like the NIFTY index made up of 50 stocks and gives the investor broad direction about the equity market. DXY gives the broad indication of dollar movement globally. For example during Covid 19 FY 2020-21, DXY jumped from 96/97 to 103 and from there retracted to as low as 89.50/90. During the same time USD-INR moved from 72.50 to 76.50+ and slowly pulled back as DXY came down. Thus price of DXY can be tracked to check USD-INR value.

Crude Oil

India imports crude Oil on a very large scale which contributes around 20-22% share. Higher the crude oil prices INR would depreciate more.

Capital Flows

As we track FPIs number in the equity market, similarly FX traders watch capital flows in economy. Higher the flows, higher the possibility of INR appreciating against dollar. Also when the outflows are higher rupee can weaken more than dollar.

Risk Sentiments

It defines how the market is looking at risk. Better the risk sentiment, better for EM currencies. The best indicator to gauge risk sentiment is performance of global equity market and other risks assets like commodities and it is also dependent upon global growth and liquidity.

RBI Intervention

This is a difficult task to guess when RBI can intervene in FX market. The point to be remembered here is FX also has an impact on external trade and competitiveness of Indian products in international market. Hence, RBI, at times intervenes to ensure orderly price movement and maintain export competitiveness.

Why is USD becoming stronger than INR?

The Year 2022 was not so good for Indian Rupee. The reasons included global tantrums and domestic factors such as rising inflation. Dollar strengthened amid Russia-Ukraine conflict, global inflation concerns led surge in US Bond Yields, and the result is an appreciating Dollar.

Supply chain disruptions and food inflation have added up to the above reasons. Russia-Ukraine war seems to have no solution and there is a slowdown in world’s three largest economies i.e. US, China and Europe. Though Indian currency looks weaker, but there is an expectation that Indian economy will perform much better in the near future in the second half of the year 20

In the past few weeks, Corporate Dollar Demand, foreign fund outflows, risk averse sentiments and broad based strength in the dollar are the major factors that contributed to push the rupee towards lower side. Also rise in inflation has put a high pressure on the Reserve Bank of India to hike interest rates. But in the near future the spot USD/INR seems to be bullish momentum oscillators and indicators.

Conclusion

Thus it can be said that US Dollars is considered as the benchmark for global transactions and therefore it has a direct impact upon the strength of the Indian Rupee. India being US’ ninth largest goods trading partner , the two countries enjoy strong collaborations in precious metals and stone, mineral fuels and pharmaceuticals which makes the USD/INR pair an exciting one for the traders looking to earn profit for long term and also for short term opportunities.