Sunday, April 30, 2006

Effect of exchange rate movements

In a perfect economic system, the changes in relative strength of a
currency should not affect the relative strength of any other 2
currencies. However, we live in an imperfect world. The currencies of
various economies are market driven to a different extent.

For instance, Chinese Yuan is pegged to dollar. Indian rupee in partly
market driven and any major move is scuttled by RBI through open
market operations. In such a case if the dollar loses strength it will
not only affect the trade equation between India and US but it will
have impact on trade equation between India and any other country.

If rupee appreciates against dollar but Yuan doesn't then the Indian
export will become less competitive in compared to Chinese exports.
These countries compete in many areas and dollar devaluation can
affect the economies quite a bit.

More specific impacts of weakening dollar are listed below:
1. Company's who have raised debt through ECBs denominated in dollars
would gain because they have to pay back fewer amounts in rupees.
2. Companies with dollar denominated exports will suffer exchange
losses. Such losses can amount to large figures unless company
actively manages exchange risk.
3. Companies which are importing dollar denominated goods/raw material
like capital goods/crude etc will benefit from lower cost.
4. Companies competing against countries like china will suffer due to
relative appreciation of their currency against an inflexible/pegged
5. India's 130bn $ forex reserves would lose their sheen but you will
never see forex loss reported in any financial statement from india.
6. A huge and unsustainable reserve position may force government to
open up some restrictions on convertibility, foreign investment by
Indian companies etc. This will be a beneficial impact.

To summarize I'm more worried about appreciation against competing
Asian currencies than against dollar.

Posted:Feb 8, 2005

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