Why price of a currency increase & decrease? For example USD vs INR

While writing this article, I have an ominous feelings. While rupee was trading at 65 to a dollar about 8 months back, now it's trading around 74.

Should the sanction on Iranian crude fructify to the extent the world fears, rupee can shoot over 75 easily.

Let's delve into what affects our currency. What causes our currency to weaken or strengthen ?

Currency is basically a function of many factors:

Dollar effect on INR

* If inflation rises in other countries, especially in US, it bodes ill for our country. If inflation rises in US, ultimately FED has to raise interest rate, to keep inflation under control. In case, FED hikes interest, RBI has to raise interest on INR. Otherwise, the return on dollars will be more attractive than rupee. It will cause instantaneous outflow of rupee (selling) and buying of dollars, crashing our market.

Why is dollar so important or used as reserve currency?

* USD is the reserve currency globally. Renminbi (Chinese currency) tried to usurp it from it's position, but it was not been successful. One major reason for this is the difference in functioning of Fed and People's bank of China. By means of constitution, Fed is independent to calibrate dollar as per ongoing parameters of economy, while Renminbi is calibrated not independently, but under the hawk eye of Chinese communist government. This makes the Chinese currency inflexible and more attuned to appeasement of People's Government Of China. The dollar is perceived as a much stronger democratic currency, which incidentally carries the backing of the world's strongest, powerful nation.

*It's not for nothing that dollar is the reserve currency of our globe. If you check the events after the collapse of Lehman Brothers and the financial rout following that in 2008, the ramifications of which continued deep into 2009, you will notice the US economy was the first to get out of the woods.

Even in 2018, while writing this article, Italy is still doubt full, while Greece is yet to come clean from debts taken from European Union and IMF. Japan is yet to emerge from deflation, and China is highly leveraged country. That leaves Dollar as the reliable , rock steady currency on which the world can rely, and the only medium of global buy , sell.

Effect of dollar on Indian Rupee

The net result is that when dollar catches cold, INR suffers too. If USA economy suffers from stagflation, FED will reduce it's interest rate. Now if India doesn't follow suit, it's export will suffer , because the INR will be at comparative higher rate wrt. USD and that will make India's products costlier.

Effect of crude oil on Indian Rupee

India has to import 80% of it's crude oil requirements. What's in that you would ask? Nothing Sir, there's only a slight hitch.All over the world crude is priced in dollars. So whenever Brent crude rises over 60$, India gets in serious trouble. More dollars have to be paid for buying, resulting in larger trade deficit. This results in further weakening of the rupee. The situation continues, rupee weakens further, till price rise stops.

However, not all is lost and there's a natural brake to how much oil can rise. As oil rises, superusers like China and India's economy will falter and they will consume less. So ultimately supply will trump demand and price will turn down.

Some factors that affect our domestic currency, Rupee

Four important items which are responsible for India's CAD are electronic items, gold, crude oil, pharmaceutical constituents. In times of weakened rupee (like now at 74 to a dollar), government tinkers with the import duty on these goods (especially on non core items like gold, mobile) to bring down the import, thus stopping dollar outflow and prep up the rupee .

Rainfall, thunderstorm, snowfall, in short seasonal natural events/calamities affect our currency greatly Lower than average rainfall means less agricultural production. Less agricultural  production necessitates import of food/foodgrains, increasing MSP for farmers, more subsidies in short everything% vs that increases CAD. So rupee weakens.A good monsoon has the exact opposite effect.

How is currency useful to business apart from buy sell medium?

Currency is one of the main tool for controlling inflation. Inflation is like diabetis, eating up the economy silently. It clogs demand and impacts every sector of economy. The main weapon of RBI in fighting inflation is increasing rate of interest on currency. Other tools of controlling liquidity apart from currency is increasing SLR for banks, Repo rate etc.

In our country currency future positions are traded in MCX-SX , NSE, BSE. It's a great hedge tool for companies taking loans in dollars or having foreign convertible currency debts. Importers and exporters can also use the futures positions available through exchanges to save themselves from losses, should USD-INR rate slide down or shoot up.

For traders, currency is a great low cost trading tool (compared to equity futures), for RBI it's a mighty tool to tune country's economic direction, for exporters and importers it’s a great hedging tool.