InvestorQ : How does the demand and supply of currency get built up and what are the key triggers?
rhea Babu made post

How does the demand and supply of currency get built up and what are the key triggers?

Niraja Mehta answered.
3 years ago

When there is selling in equity markets, it is expected that FIIs will take dollars out of India. That triggers a demand for dollars. Similarly, if the expectation is that the dollar will get stronger then importers and forex borrowers will rush to buy dollars. That will create a demand for dollars and make the USD/INR pair move higher. But what creates a greater supply of dollars and leads to a strengthening of the rupee?

This normally happens when the INR is expected to appreciate. For example, the day the India rating was upgraded by Moody’s; there was a sharp increase in supply of dollars from exporters. These exporters preferred to convert their dollars into INR. Typically, this kind of surge in supply results in the dollar weakening and the pair value goes down. Similarly, heavy buying by foreign investors or strong FDI flows are also positive for the rupee vis-à-vis the US dollar. More often than not, it is the dollar strength that drives the exchange rate of the rupee vis-à-vis all the currencies since most of our global trade and flows are still denominated in US dollars. So what drives the dollar?

There are quite a few such events that can end up strengthening the dollar. If the Fed hikes the repo rates, then the dollar bonds become more attractive and hence the dollar will strengthen. If the US GDP is likely to improve then again the dollar will strengthen. If the US government is going to increase consumption through tax breaks, that will also strengthen the dollar. You can play all these events in the currency futures market by purchasing USD/INR pairs. Also since most of the global commodities are denominated in dollars, their values also tend to be negatively related to the dollar.