Currency Depreciation and Currency Appreciation

What is Currency Depreciation?

It refers to the decrease in the value of the domestic currency (₹) in terms of one or more foreign currencies (like $). It makes domestic currency less valuable, and more is required to buy a unit of currency. For example, if the price of $1 rises from ₹60 to ₹64, then it can be said that there is a depreciation of the Indian currency.

The main factors contributing to currency depreciation are easy monetary policy and excessive inflation. It can also be caused by political instability. Due to uncertainty in the domestic country, investors fear investing in the domestic country. For example, Due to the war between Russia and Ukraine investors fear investing in the country because of instability in the economy. Besides, if the country imports large amounts of products, then there will be a trade imbalance, which will lead to currency depreciation.

Effects of Currency Depreciation on Exports:

Currency depreciation means a fall in the price of domestic currency (₹) in comparison to foreign currencies ($). For example, earlier people can get goods worth ₹60 from a unit of the dollar, but now they can get goods worth ₹64 from 1$. It means that more goods can be purchased from India in rupees with the same amount of dollar. Thus it leads to an increase in exports from India to the USA, as exports become cheaper.

What is Currency Appreciation?

It refers to an increase in the value of a domestic currency (₹) in terms of one or more foreign currencies (like $). It makes the domestic currency more valuable, and less of it is required to buy a unit of currency. For example, if the price of $1 falls from ₹64 to ₹ 60, then it can be said that there is appreciation of Indian currency. The main factors contributing to currency appreciation are interest rates and inflation. In the case of low inflation, there is an increase in interest rates, and higher rates attract more investors in the overseas market, which will ultimately increase the value of the domestic currency. Another main reason is investor sentiment. If an investor feels that his/her money is safe in the economy; i.e., there is political stability in the country, then it will attract capital flows from overseas leading to an increase in the value of the domestic currency.

Effects of Currency Appreciation on Imports:

Currency appreciation means a rise in the price of domestic currency (₹) in comparison to foreign currencies ($). Earlier, for example, an Indian resident needs ₹64 to buy a unit of dollar, but now he needs ₹60 to buy the same. It means that more goods can be purchased from the USA with the same amount of rupees in dollars. Thus, it leads to an increase in imports from the USA to India as American goods become cheaper.

Different countries have different methods of determining their currency’s exchange rate. It can be a Fixed exchange rate, Floating exchange rate or Managed Floating exchange rate.