What is Currency Appreciation & What Causes it

Introduction

Have you ever wondered why the Indian rupee's value fluctuates over time? If you have some Rupees, why may sometimes you buy more Dollars or Euros? Currency appreciation, or the rise in value of one currency compared to another, is the key to understanding this phenomenon. Let's talk about what causes a currency to appreciate, how it happens, and what it means for India's economy and culture.

What is Currency Appreciation?

Appreciation of one currency relative to another is known as currency appreciation. Suppose the Indian 'rupee' and the US dollar exchange rates drop from 75 to 70 rupees per dollar. The rupee would then have risen in value relative to the dollar. To put it another way, one rupee is now worth more than it did a year ago.

Appreciation of a currency is distinct from its depreciation. When one currency loses value relative to another, this is called a currency depreciation. 

How does Currency Appreciation Work?

The mechanism of supply and demand governs currency appreciation on the foreign exchange market, where currencies are traded. Multiple factors impact the foreign exchange market.

When a currency's demand exceeds its supply, its price or value increases. It occurs when more people want to purchase or hold a currency for a variety of reasons, including investing, trading, saving, or traveling. If more foreign investors wish to invest in India, for instance, they must purchase rupees. This circumstance will increase the demand for rupees and drive up their value.

When a currency's supply exceeds its demand, its price or value decreases. It occurs when more individuals wish to sell or dispose of the currency. When numerous Indian exporters wish to sell products abroad, for instance, they convert rupees to foreign currencies. This action decreases the value of the rupee by increasing its supply.

What Causes Currency Appreciation?

Some of the common causes of currency appreciation are:

1. Higher Interest Rates 

When a nation raises its interest rates, it attracts greater inflows of foreign capital. Investors pursue higher returns on their investments. This increases demand for that country's currency, causing its value to rise. For instance, if India raises its interest rates above those of the United States, more foreign investors will be interested in purchasing Indian bonds or deposits with higher interest rates. This will cause the rupee to appreciate against the dollar by increasing its demand.

2. Strong Economic Growth

When a country's economy is thriving and developing faster than the economies of its trading partners, it demonstrates that it is financially stable. This strengthens its confidence and reputation on the international market. Because of this, other nations and businesses are eager to invest in the country, and its tourism industry also thrives. All of this increases demand for that country's currency, which causes its value to rise.

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3. Positive Market Expectations

When a country's future economic prospects or policies are viewed favorably by the market, it generates a favorable sentiment among investors and traders. This motivates them to purchase or hold that nation's currency in anticipation of higher returns or reduced risks. This increases demand for that country's currency, causing its value to rise. 

If Indian investors anticipate a promising budget or reforms, their outlook will be optimistic. They may contemplate buying or holding more Indian rupees in anticipation of improved growth or tax cuts. Here, the increased demand for rupees causes their value to rise..

What are the Effects of Currency Appreciation?

Currency appreciation can have various effects on the Indian economy, depending on the extent and duration of the appreciation. 

Some of the common effects are:

• A stronger currency can make it more expensive for foreigners to travel to your country. This could result in fewer visitors, affecting local businesses such as hotels, restaurants, and attractions that rely on tourism.
• Currency appreciation reduces India's inflation rate, thereby lowering the prices of imported inputs and substitutes in the domestic market. This reduces the pressure on the central bank to increase interest rates in order to control inflation.
• Currency appreciation can increase unemployment in India, thereby decreasing export demand. This can result in employment losses in export-oriented industries like textiles, gems and jewelry, and software. 

• Also read :- Bank of England pauses interest rate hikes as economy slows

Conclusion

Currency appreciation is a complex phenomenon that can affect the Indian economy and society in both positive and negative ways. It may be advantageous to some sectors and groups while detrimental to others. It may also have distinct short- and long-term effects. Therefore, it is crucial to comprehend its causes and effects and to implement policies to mitigate its impact.