InvestorQ : Dear sir , I have recently started trading in currencies. can you guide me what are the factors determining USDINR exchange rates?
Girish made post

Dear sir , I have recently started trading in currencies. can you guide me what are the factors determining USDINR exchange rates?

seema Upadhyaya answered.
3 years ago
As you rightly observed, the currencies are traded in pairs and that way they are different from other classes. The USDINR is a popular future pair that is traded on the currency futures segment in India and there are a number of factors that determine the currency value. Just to give you a quick idea, bullish on USDINR you are long on dollar and short on the rupee. Similarly, bearish on USDINR means you are short on the dollar and long on the rupee. Here are the factors that impact the USDINR value.

Rate of retail inflation (CPI) in India. The real effective exchange rate (REER) is a barometer of whether the currency in question is overvalued or undervalued. If India‚Äôs rate of inflation is 6% and the US rate of inflation is 2%, then the Indian rupee must depreciate each year by around 4%. 

The real rate of interest in the economy. There is a positive relationship between the real interest rates and the INR value. That is why whenever the RBI hikes rates, the INR actually sees an appreciation in value because of the higher rates of interest increase the real rates of interest.

Seasonal dollar demand from importers and banks. In the case of importers, there are regular remittances that have to be made against goods imported. Normally, when demand for dollars tends to get bunched together, you see pressure on the INR and a weakening of the rupee.

Fiscal and trade-related factors are more long term in nature. Economies with consistently elevated levels of trade deficit tend to have a weaker currency. An important factor that determines the rupee strength is how many months of forex cover the RBI has. Fiscal discipline is a major positive for the INR.

Government intervention plays a key role in the value of rupee. RBI does make an effort to maintain the INR in a tight trading range so that importers and exporters are not subjected to shocks. RBI not only directly intervenes in the currency spot markets but also hedges its exposures through the currency derivatives market.

Federal Reserve monetary stance. When the Fed increases rates the dollar strengthens and that leads to a consequent weakening of the INR. The Fed monetary stance is not only important from the point of view of rates but also from the point of view of the tapering of the bond portfolio. 

Keep an eye on the Bloomberg dollar index (DXY). The dollar index (DXY) is an index of dollar strength weighed against a basket of hard currencies. Therefore the dollar index is not only about the strength of the dollar but also the weakness of the other hard currencies vis-a-vis the dollar. It tends to also impact the USDINR equation.

Capital flows; both FPI and FDI. Foreign direct investment (FDI) is stable money while FPI flows are referred to as hot money. Capital flows are responsible for sharp movements in the INR. Normally, capital outflows tend to have a domino effect on the rupee and the markets.