Weakening Dollar
Posting the article 'Weakening Dollar' on behalf of CEan - KGV
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Recently the dollar prices fell by some considerable amount with respect to most of the currencies. Here in India the Rupee rose to around 40-41 a dollar from around the 45 rupees a dollar mark. There is a lot of panic among the exporters because a weak dollar causes the exporters, especially in the services sector who have all their expenditure in rupees and earnings in dollar.
Consider a firm 'K software' that has a profit margin of 5 %. Now 'K software' bags a contract of 100,000 USD from a big US based firm when the dollar Rupee exchange rate is 45 Rs a dollar. So the profit of 'K software’ would be 5 % of 100,000 i.e. USD 5k (= 225k Rs at the exchange rate of 45Re= 1USD) and expenditure which is in Rupees as USD 95k i.e. 4275k Rupees. Therefore, 'K software’ goes ahead with its project and when the project is completed the dollar gets weak and trades at 40 Rupees a dollar. Now 'K software' has already spent 4275k and now despite getting the promised 100,000 USD they get only 4000K rupees and end up, in effect, paying 275k for developing the software. So weakening of dollar is detrimental for the exporters.
Importers on the other hand have to pay less to import the same thing suppose you buy a 100$ iPod now you will have to shell out just around 4k instead of the earlier 4.5k. This is one of the reasons why all those Oil economies which are primarily the importers maintain very high exchange rates by regulating their currencies. For example, one dinar costs you somewhere around 120 rupees. Now for one dinar someone can buy around 2.75 dollars so all the imported stuff is cheap and the common man can afford all the imported stuff. On the other hand export oriented economies like China and Japan maintain a very cheap currency so that the exporter is encouraged to export (as 1 dollar can fetch you around 40 Rs anyone would like to earn in dollars) also by keeping a cheaper currency the exports are cheap too. For example, consider that an item costs 100 units of the local currency to be manufactured now if a country say China maintains the exchange rate of 25 Yuan (the currency unit of China) by regulation and another country Japan maintains the exchange rate of 20 Yen (the currency unit of Japan) by regulating its economy, now the basic costs incurred in both countries are same i.e. 100 Yuan and Yen respectively. But when an American customer buys it in dollars he has to spend 4 dollars to buy the Chinese product while 5 dollars to buy the Japanese one. So China manages to keep its exports cheaper and sell more while Japan loses out just because of higher exchange rates.
The logical question which then follows is that why don't countries keep their exchange rates extremely low? The answer lies in the fact that each country has to import something or the other, also the currency rates are governed by the demand supply and hence they can just be regulated but not completely controlled. There are several other implications of keeping a weak currency which cannot be discussed here. Yes, the current weakening of dollar is not because of any regulatory measures by the US govt. because it wants its exports to India to be cheaper , it is rather an outcome of huge dollar reserves that India has built up recently and due to these reserves the supply is boosted while the demand is nearly the same and hence the dollar has weakened. I am happy that I don't have any assets in dollar but I'll love to have some in future
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-The Big K-
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Recently the dollar prices fell by some considerable amount with respect to most of the currencies. Here in India the Rupee rose to around 40-41 a dollar from around the 45 rupees a dollar mark. There is a lot of panic among the exporters because a weak dollar causes the exporters, especially in the services sector who have all their expenditure in rupees and earnings in dollar.
Consider a firm 'K software' that has a profit margin of 5 %. Now 'K software' bags a contract of 100,000 USD from a big US based firm when the dollar Rupee exchange rate is 45 Rs a dollar. So the profit of 'K software’ would be 5 % of 100,000 i.e. USD 5k (= 225k Rs at the exchange rate of 45Re= 1USD) and expenditure which is in Rupees as USD 95k i.e. 4275k Rupees. Therefore, 'K software’ goes ahead with its project and when the project is completed the dollar gets weak and trades at 40 Rupees a dollar. Now 'K software' has already spent 4275k and now despite getting the promised 100,000 USD they get only 4000K rupees and end up, in effect, paying 275k for developing the software. So weakening of dollar is detrimental for the exporters.
Importers on the other hand have to pay less to import the same thing suppose you buy a 100$ iPod now you will have to shell out just around 4k instead of the earlier 4.5k. This is one of the reasons why all those Oil economies which are primarily the importers maintain very high exchange rates by regulating their currencies. For example, one dinar costs you somewhere around 120 rupees. Now for one dinar someone can buy around 2.75 dollars so all the imported stuff is cheap and the common man can afford all the imported stuff. On the other hand export oriented economies like China and Japan maintain a very cheap currency so that the exporter is encouraged to export (as 1 dollar can fetch you around 40 Rs anyone would like to earn in dollars) also by keeping a cheaper currency the exports are cheap too. For example, consider that an item costs 100 units of the local currency to be manufactured now if a country say China maintains the exchange rate of 25 Yuan (the currency unit of China) by regulation and another country Japan maintains the exchange rate of 20 Yen (the currency unit of Japan) by regulating its economy, now the basic costs incurred in both countries are same i.e. 100 Yuan and Yen respectively. But when an American customer buys it in dollars he has to spend 4 dollars to buy the Chinese product while 5 dollars to buy the Japanese one. So China manages to keep its exports cheaper and sell more while Japan loses out just because of higher exchange rates.
The logical question which then follows is that why don't countries keep their exchange rates extremely low? The answer lies in the fact that each country has to import something or the other, also the currency rates are governed by the demand supply and hence they can just be regulated but not completely controlled. There are several other implications of keeping a weak currency which cannot be discussed here. Yes, the current weakening of dollar is not because of any regulatory measures by the US govt. because it wants its exports to India to be cheaper , it is rather an outcome of huge dollar reserves that India has built up recently and due to these reserves the supply is boosted while the demand is nearly the same and hence the dollar has weakened. I am happy that I don't have any assets in dollar but I'll love to have some in future
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-The Big K-
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