Why does the US Dollar and the exchange rate matter so much to India?

“In India, there is one currency that is the centre of all conversation, that we talk about with great excitement — and in fact, it even affects our day-to-day life. But strangely, this is not our rupee.

It’s the U.S. Dollar.

The U.S. Dollar has great power. Whenever the value of the rupee falls against or when compared to the dollar, it always makes headlines. There is a lot of panic. We all know this happens.

But why, exactly? What is it about the US Dollar and the exchange rate that causes ripples in our country and its economy?”

Show Notes

All clips and voices used in this podcast are owned by the original creators

Links to clips used in this episode —

• Why the rupee is falling – ABP News – https://www.youtube.com/watch?v=cl-7rbe8T_E
• Rupee falls to an all-time low – ABP News – https://www.youtube.com/watch?v=bBCr7L0s1Sc

Full Transcript of Episode 32 –

In India, there is one currency that is the centre of all conversation, that we talk about with great excitement — and in fact, it even affects our day-to-day life. But strangely, this is not our rupee.

It’s the U.S. Dollar.

The U.S. Dollar has great power. Whenever the value of the rupee falls against or when compared to the dollar, it always makes headlines. There is a lot of panic. We all know this happens.

But why, exactly? What is it about the US Dollar exchange rate that causes ripples in our country and its economy?

Today, we’ll try to answer questions about the US dollar that we’ve always wondered about — how does the US Dollar exchange rate work? Why is it so important?

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[We hear news reports about the fall of rupee against the Dollar]

What we just heard is the value of rupee against the dollar. Jisko hum kehte hai, the US Dollar-Rupee Exchange rate.

And what do we mean by this? Quite simply, the exchange rate is the number of units of one currency — yaani, mudra– that you can exchange for a single unit of another currency. Jaise,if you want to buy one dollar, you’d have to pay around 74 rupees. 74 is the exchange rate of the US dollar against the rupee.

But, how did this even begin? The answer is simple: business!

The entire world, as we know, does not have a common currency. We have the rupee, the US has the dollar, Saudi Arabia has the riyal. So when we need to do business with these countries, we need an exchange rate to establish common ground with these countries.

Take for instance, the US dollar. We import many different things from the US. These items are priced in Dollars. We get our oil from the Middle East, electronics and machinery from China. We also export to these countries, as well as countries like U.K., Germany, Hong Kong … this list is long.

Now when we do business with all of these countries, we need to do it all in different currencies. Pay the US in dollars, Saudi Arabia in Riyals, sell goods to the U.K. in pounds — what confusion!

Wouldn’t it be much better — much easier, if international trade, across the world, happened in one common currency?

That’s where the U.S. Dollar comes in. The U.S. Dollar is considered to be a global currency. But it is not the only one.

Global Currency, by the way, simply means that it is a common currency that different countries trade in, and that they reserve in their banks. In India, the Reserve Bank of India has a major reserve of US Dollars. This is what we call the Foreign Reserve.

We already know that there is an exchange rate between any set of two currencies. It’s not just between the rupee and the dollar. But then, why is the dollar exchange rate so important?

And more importantly, what happened that made the US dollar the global currency, and not any other country’s currency?

Let’s find out.

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Doston, the globally powerful status of the dollar is actually (darasal) a fairly new phenomenon. The dollar was not always so valuable.

The U.S. Dollar was a simple currency used in the country for trade. The dollar actually came from the Spanish currency Peso, which used to be called Thaler (तालेर). In the 1500s, the English colonists of America used to conduct extensive trade with colonies on the Spanish coast. Thaler became a very common currency in the American colonies — they started calling it “dollar”. When the time came for American leaders to fix a national currency 200 years later, they chose the name dollar, which was already familiar to the country.

Actually, if you imagine letter S for Spanish and P for Peso on top of each other, you might get something like…the U.S. Dollar sign. That’s where it comes from!

But let’s get back to our story.

Like I said, the US Dollar was a simple currency being used in the Northern Americas. Now, let’s rewind back 100 or 200 years. Just like today, there was no common currency, but International Trade was flourishing. But wait, without the US dollar, what did they use for trade?

It was gold.

Hua yeh tha, ki countries started doing business with one another, but there was one problem: every country had a different currency. In those days, currency was not notes and cards like today, each country had coins with different values. This made foreign trade difficult, as you can imagine. Metal coins were complicated to trade with, but paper money did not have any value! This is when it was decided to bring in gold as a standard of currency, something which had equal value across the world.

Countries compared the value of their currencies with gold, and printed paper money worth this value. So, the price of the currency was linked directly to the price of gold. If they needed to print more money, then they needed to increase the amount of gold they had in their possession. Gold those days was equivalent to the dollar of today — a common unit to compare all currencies with.

This made foreign trade stronger, and more trustworthy for all the countries.

The next step is: the US Dollar!

If someone asks you why the U.S. Dollar is such a powerful currency today, then the moment in history that you can point to is World War I.

Till World War 1, the British Pound was the most powerful currency for many decades. But the U.S., which was rising in terms of trade, was on a mission to make its currency powerful. During the war, New York banks started loaning dollars to European countries, which increased its circulation. At the same time, the British economy was suffering. So, countries began to hold Dollars in reserve instead of the Pound.

I mentioned the term “Reserve Currency” ya आरक्षित मुद्रा a couple of times now — let’s understand this quickly.

Around the world, countries have a reserve of a certain powerful foreign currency which means they store some amount of this currency with them. This can be the dollar, the Pound, the Yen, etc. Basically, any currency with which a country can trade internationally. This reserve is created to pay off international debts, buy commodities and deal with financial crises. So, while we do not have a world currency, we do have reserve currencies. This comes closest.

Around the 1930s, some countries stopped using the Gold Standard, since it was getting difficult to maintain so much gold to back up their currency. Now, we needed a better exchange rate system!

In 1944, delegates from all of the World War II “Allied nations” met at a conference in Bretton Woods (ब्रेटन वुड्स), New Hampshire (न्यू हैम्पशायर); mainly to create an efficient foreign exchange system. So here, they came up with the Bretton Woods Agreement, under which most countries around the world actually “pegged” their currency to the dollar — matlab?

Pegging your currency to a foreign currency means setting a fixed exchange rate for your currency with the foreign currency. This is one way to stabilize your currency aur isse kya hota hai, that trade in the country remains stable.

In this conference, member countries decided to peg their currency to the US Dollar. While the Gold Standard had ended, it was decided that the Dollar would be linked to gold for foreign exchange, so that there would be an international standard for exchange.

Basically, the countries pegged their currency to Gold.

This, however, isn’t the end of the story — we jump to 1971, when a new agreement was put into place — the Smithsonian (स्मिथसोनियन) Agreement. Bretton Woods was done away with.

Iske mutabik, foreign currencies would be pegged directly to the dollar, and not gold.

What happened in the next few decades? The long and short (mote-mote tareeke se) of it is: The U.S emerged as a superpower, with a strong economy and an even stronger currency. Countries around the world started trusting the dollar, and keeping reserves of it. Global commodities like oil, metals, foodgrains are priced in dollars. The exchange rate with the dollar became extremely important for other countries — because now, it affected their economies too.

Eventually, the countries decided to remove their peg to the dollar or continue it. But regardless of their choice, the US Dollar had become one of the strongest currencies in the world, used widely for international trade.

And that’s how the Dollar went from the local currency to a Global phenomenon.

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Now that the dollar has made its trip around the world in our episode, let’s come back to India!

A few years ago, an exciting fact was reported in the news. You might remember this — It said that in 1947, one rupee was equal to one dollar!

In fact, Narenda Modiji even tweeted about this in 2013. It’s impossible to imagine now, when the exchange rate is more than 70!

But is there any truth to this?

Let’s look at how the Dollar Exchange Rate has worked in India and find out if this was true.

On the surface, the concept of Exchange Rate might sound easy. But in reality, there are many different kinds of exchange rates. The interesting thing is, over the years, India has tried and tested almost every kind of exchange rate for its rupee!

Remember when we talked about the Bretton Woods Conference of 1944? India, too, was a member country in this conference. The deal that was decided at the end of this meeting was that every country will peg its currency to the US Dollar — which was linked to Gold. India chose to peg its currency to gold so that every rupee was worth about 4.15 grams of gold. This system was called the par value system of fixed exchange rate. Yeh ho gaya ek kind of exchange rate.

The exchange rate of the dollar doesn’t even come into the picture for the next two years. So, the big claim that one rupee was worth one dollar comes from the par value system. But as I said, we pegged our rupee to gold, and not to the U.S. dollar. So this claim is not actually backed by any data!

Aate hai 1949 pe.

We devalued the rupee against the Dollar. Before this, it was around Rs. 3.30. Now, 1 dollar was worth Rs 4.7.

The next round of devaluation happened in 1966. Remember, India is still following a fixed exchange rate system. But since 1950, we had been seeing a slow but sure financial crisis building in the country. There were deficits in our budget, and we had international debt on our shoulders. In the 1960s, India was also going through a hunger crisis! Help from foreign countries was our only way out of this. In 1966, to deal with all these issues, Prime Minister Indira Gandhi took a huge step. On 6th June, 1966, she devalued the rupee against the Pound from Rs. 13.33 to Rs. 21. As a result, the exchange rate with the dollar became 7.50.

In a way, this was the first time India was liberalized.

You can find out more about the story of 1966 in our episode about liberalization — but as far as the exchange rate of the rupee was concerned, this was a major step in its journey!

In 1993, the rupee abandoned the fixed exchange rate, finally. It started following the floating exchange rate system. This was a result of the New Economic Reforms of 1991.

Now, the government had no control over the rupee. Neither did another currency, as the case was before. According to the floating exchange rate system, the value of the rupee against any other currency is determined by the trends of supply and demand of the market. This system had continued till this day.

The Floating exchange rate system means that the rupee still had a small amount of flexibility. It didn’t change with the value of gold or with the value of the Dollar, but with the market. So where does the Dollar come in now….

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As soon as the rupee falls against the dollar, news channels, financial advisers and even the general public starts talking. The opposition blames the government, the government blames…the crude oil prices, usually 🙂

But, let’s get serious. Doston, think about it: is it always harmful when the U.S. Dollar becomes more expensive?

Look at the larger picture here. We import many items, but we also export to other countries in Dollars. When the value of the rupee falls against the dollar, it means that the same item will fetch more rupees, when sold in Dollars. A weaker rupee makes it easier for Indian companies to export items. This creates jobs, and has a positive impact on the economy.

So, it’s not about how high or low that US Dollar exchange rate is. It benefits some people when it’s high, and others when it’s low. The reason that the US Dollar exchange rate is so important to us is that it suits the Indian economy in every situation — high or low.

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Doston, did you know that in 2018, an economic crisis in Turkey caused the rupee to fall?

Actually, India, Turkey and many other Asian countries are referred to as ‘emerging markets’. Isme aisa hai, ki if a currency in any one of these countries drops, foreign investors back out from other emerging markets too. The Rupee fell to a record low against the dollar because of this crisis.

What I’m trying to tell you with this example is that the value of a rupee depends on many factors: market trends, crises, the price of crude oil. The US Dollar-Rupee relationship, too, is dependent on these very factors.

At its core, the exchange rate simply depends on what’s happening in our country. Are we suddenly importing more goods? Or perhaps, a huge Indian company opens a branch in the US? This means that we are spending more dollars from our foreign reserve. And the more dollars we spend, the more the demand of the dollar — and the more expensive it gets.

In the same way, if the supply of dollars suddenly increases in the market, then its price will go down — and the value of the rupee will increase.

Even inflation is a factor!

Suppose the Inflation rate in India is higher than that in the U.S. This means that there’s a price rise in the Indian market, and commodities are suddenly more expensive. It’s possible that these commodities are cheaper to import – and that means, a demand for dollars will increase. It all comes down to demand and supply, in the end!

So we want a strong rupee, against the dollar. We can’t control the market forces, so what can we do?

Actually, we can control the market forces, kuch-kuch. Like I said, for the value of the rupee to go up, the supply of the US Dollar in our market will have to be more than its demand. Simple words mein kahe toh, we want more dollars. One of the ways we do this is by inviting foreign investments in the market. Jitne zyada foreign investor, utna accha, for our economy.

But a foreign investor is careful with their dollars. They will only invest in a country which has a stable currency, which is not going to be devalued any time soon. And of course, they want to earn profits — so their eye is on interest rates.

Yahan aati hai market control ki baat. If our rupee is falling rapidly, something the RBI can do is increase the interest rate of bank deposits. This happened in 2012. When the rupee was falling, the RBI decided to increase the interest rate on NRI – yani, non-resident Indian – deposit accounts. This led to a huge inflow of dollars into Indian banks.

Rupee? Saved!

But, wait. This is where it gets interesting — the rupee does not always need saving. When it falls, it does affect our economy. But in this situation, export industries such as Pharmaceuticals and Information Technology benefit from it.

A high exchange rate is good for some people, a low exchange rate is good for others.

But throughout this episode, we’ve realized that the exchange rate is as dependent on supply and demand in the country, but at the same time can be affected by an economic crisis in a totally different country.

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Doston, The U.S. Dollar will always remain a point of contention in our lives.

It’s integrated so deeply into our economy, that it’s hard to separate the rupee from the dollar. History also backs this up: over the last hundred years, the U.S. Dollar has grown more and more important to countries around the world. And in our country, it is often viewed as a dangerous factor that harms our economy. But for us Indians, I’d say, the dollar isn’t the enemy, and this is not a competition. It’s just an extremely important part of our economy.

That’s all I have for you today, folks! Hope we were able to answer a question we all had. Thanks for tuning in, see you next week in a brand new episode of Maha Bharat!