Currency Appreciation and Depreciation: How does it Affect Exports and Imports

Currency Appreciation and Depreciation: How does it Affect Exports and Imports

Ms. Deeksha | Faculty at JIMS Kalkaji | jagannath.org

By Ms. Deeksha

Currency Appreciation and Depreciation | JIMS Kalkaji | jagannath.org

Summary- For graduates looking to pursue a career in finance, the pgdm course offered at JIMS Kalkaji with specialization in finance is a great opportunity to get taught by industry experts. This article gives an insight into the impact of currency market on international business.

Long ago, people exchanged services and goods for other services and goods in return – called the barter system. As time went by, instead of bartering, people started using money as a medium for trading and exchange, since it has an exact value and easier to carry around.

Today, people use paper money as a medium of exchange. The paper money, also called fiat money, is the government-issued currency that is not backed by a physical commodity but by the stability of the issuing government. There are a number of reasons that can contribute the change in currency and affects its valuation.

What is currency appreciation and depreciation?

  • Currency appreciation is an increase in the value of country’s currency with respect to one or more foreign reference currencies, in a floating exchange rate system.

There are number of reasons that contribute currency appreciation, including government policy, interest rates, trade balances and business cycles.

  • Currency depreciation is the loss of value of a country’s currency with respect to one or more foreign reference currencies, in a floating exchange rate system.

Depreciation of currency can occur due to any number of reasons – economic fundamentals, interest rate differentials, political instability, risk aversion among investors, etc.

For example:

If we say, USD/INR = 100, this means

The first of the two currencies (USD) is the base currency and represents a single unit, or the number 1 in the case of a fraction such as 1/100. The second is the quoted currency and is represented by the rate as the amount of that currency needed to equal one unit of the base currency. The way this quote reads is: One U.S. dollar buys 100 units of Indian Rupee.

For the purposes of currency appreciation, the rate directly corresponds to the base currency. For example, If the rate increases to 110, then one U.S. dollar now buys 110 units of Indian Rupee and if the currency depreciate that means one U.S. dollar can only buy Indian Rupee in the value of less than 100. Therefore, the currency depreciation and appreciation can have a part in contributing exports and imports.

How does change in currency affects exports and imports?

Exports and Imports | JIMS Kalkaji | jagannath.org

Since the exchange rate has an effect on the trade surplus or deficit, a weaker domestic currency stimulates exports and makes imports more expensive. Conversely, a strong domestic currency hampers exports and makes imports cheaper.

For example: A good priced at $10 in the U.S. will be exported to India. With an assumption that the exchange rate is 50 rupees to USD and ignoring transportation and other transaction costs, the $10 item would cost the Indian importer 500 rupees.

In a situation where, the dollar strengthens against the Indian rupee to a level of Rs. 55, and the price of good remains constant at $10, the increased price would be 550 rupees ($10 x Rs.55). This may force the importer to look for cheaper components from other locations.

The 10% appreciation in the dollar versus the rupee has diminished the exporter’s competitiveness in the Indian market.

To conclude, when a country has stronger value of currency or appreciation, they can import more goods and services from another country (assuming that the currency of exporting country remains the same). Similarly, currency depreciation leads to buying lesser in the same amount of money.

MS. DEEKSHA

JIMS Kalkaji

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