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Macro Economics

Fluctuations in Foreign Exchange Rates

Presented By
M a k a ra n d A sh o k R a n e 25

Foreign Exchange Rate

Foreign Exchange rate refers to the rate at which one unit of currency of a country can be exchanged for the number of units of currency of another country.

In the words the rate of exchange measure number of units of one currency which is exchanged in the foreign market for one unit of another.

US $ 1 = Rs.45.18

This rate is the conversion rate of every US $ 1 to Rs. 45.18

Factors Determining Exchange Rates

Fundamental Reasons: - Balance of Payment surplus leads to stronger currency. - Economic Growth Rates High/Low growth rate. - Fiscal / Monetary Policy- deficit financing leads to depreciation of currency. - Interest Rates currency with higher interest will appreciate in the short term. - Political Issues Political stability leads to stable rates

Technical Reasons - Government Control can lead to unrealistic value. - Free flow of Capital from lower interest rate to higher interest rates. Speculation higher the speculation higher the volatility in rates

Fluctuations in EURO Prices 2009-2010


What made EURO to depreciate and touch its three years low in June 2010?

EURO INR Exchange Rate Fluctuation for 2009-2010

Continued.

EURO INR Average Exchange Rate for 2009-2010


2009
January February March April May June July August September October November December

Average Exchange 64.5104 (INR) Rate


62.8849 66.8027 66.0676 66.1626 66.9191 68.2332 68.9569 70.4154 69.216 69.4421 68.0924

2010
January February March April May June July August September October November December

Average Exchange 65.5361 (INR) Rate


63.4291 61.7352 59.6338 57.6166 56.8582 59.81 60.0945 60.0771 61.7399 61.4539 59.6472

Observation

It was observed that the Euro exchange rate was stable and showed increasing trend for the initial 9 month of 2009. It had increased from INR 64 per EURO to that INR 70 per EURO till September 2009. But Since October 2009 EURO started depreciating and reached its lowest in last 3 years i.e. INR 56 per EURO, by June 2010. Since the launch of EURO in December 1998 It had always showed an increasing trend, and this period of 9 months from October 2009 to June 2010 was an exception.

Findings --Greek Debt Crisis

Years of unrestrained spending, cheap lending and failure to implement financial reforms left Greece badly exposed when the global economic downturn struck. The debt levels and deficits that exceeded limits set by the Euro-zone were revealed & exposed. In the first quarter of 2010, the national debt of Greece was put at 300 billion, which is bigger than the country's economy. The country's deficit is 12.7% of the GDP. In addition to this even Spain, Portugal, and Ireland also joined the party worsening the situation further.

Continued.

Spain

Spain has a fiscal deficit equaling 10% of GDP, unemployment close to 20% and its GDP was expected to contract by 0.5% that year.

Portugal

Portugal's deficit was a tad lower at 8.5%. The economy was expected to grow from hereon but only at a modest 0.5%. Even if fiscal deficit falls, total debt would rise to 90% of GDP.

Ireland

Ireland recorded deficit of 14.3% of GDP. Unemployment was still running at a high 13.5%. GDP contracted by 7% last year and is expected to contract in 2010 year as well by 0.9%. Meanwhile, the countrys borrowing costs have shot up from 1.7% to 3.5% for a 2 year loan.

Conclusion

In early 2010, fears of a sovereign debt crisis, the 2010 Euro Crisis developed concerning some European states This led to a crisis of confidence as well as the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members On 2 May 2010, the Eurozone countries and the International Monetary Fund agreed to a 110 billion loan for Greece, conditional on the implementation of harsh Greek austerity measures On 9 May 2010, Europe's Finance Ministers approved a comprehensive rescue package worth almost a trillion dollars aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility

Continue.

All the above actions by European governments and IMF rattled the investors and economies for the world. Financial speculators and hedge funds started selling EUROS There was sudden decrease in the demand for EURO throughout the world and USD Prices for USD started rising In response to accusations that speculators were worsening the problem, some markets banned naked short selling for a few months

Fluctuations in USD Prices 2007-2008


What is the reason that made USD , the strongest currency in Universe face downturn?

Continued.

Continued.

USD INR Average Exchange Rate for 2007-2008


2007
January February March April May June July August September October November December

Average Exchange 44.2117 Rate (INR)


44.012 43.7936 42.0176 40.5561 40.5905 40.28

2008
January February March April May June July August September October November December

Average Exchange 39.2704 Rate (INR)


39.6724 40.1452 39.9668 41.8814 42.7633 42.723 42.9248 45.4264 48.6196 48.7905 48.4804

40.6791 40.1735 39.3661 39.3168 39.3752

Observation

Over the years it has been observed that USD was a good and stable currency with average price of INR 45.5 per USD during the period of 2000-2007. Since March 2007 USD started depreciating and it touched the 10 year exchange rate of INR 39 per USD as of January 2008. USD has shown a sign of recovery slowly and gradually over a period of 1.5 years and again reached its original desired level of INR 48 per USD in October 2008, which was also quite high. Since liberalization in 1992 USD has constantly appreciated form INR 18.33 per USD to INR 45 per USD till 1st quarter of 2007, without any major fall till January 2007 .

Findings Subprime Crisis

The Subprime Boom

Real estate prices rose in the early years of this decade, and securitization provided more working capital for mortgages, lenders relaxed their underwriting criteria in order to issue more mortgages. Investors demanded higher returns on their investments and raised demand for MBSs and CDOs backed by subprime mortgages. Between 1995 and 2005, subprime mortgages increased from 5 % to 20 % of the mortgage market. By 2006 subprime mortgages had increased to more than $600 billion.

The Deterioration of the Subprime Market

In 2006, short-term interest rates rose while the value of

Continued.

In 2006, short-term interest rates rose while the value of homes leveled off or dropped. Borrowers with financial difficulties could not refinance or sell their homes to pay off mortgages when they were unable to make monthly payments. Default rates on subprime mortgages increased significantly in late 2006 and 2007. With rising defaults, purchasers of mortgages sought to force lenders to buy back nonperforming mortgages. Many smaller lenders that were inadequately reserved and unable to comply with such repurchase demands filed for bankruptcy.

Conclusion

Between June 2007 and November 2008, Americans lost more than a quarter of their net worth. Housing prices had dropped 20% from their 2006 peak During 2007, at least 100 mortgage companies either shut down, suspended operations or were sold. The crisis caused panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as "stores of value. Financial speculators seeking quick returns have removed trillions of dollars from equities and mortgage bonds, investing in food and raw materials.

Continued.

As of August 2008, financial firms around the globe have written down their holdings of subprime related securities by US$501 billion. When Lehman Brothers collapsed during a two day period in September 2008, $150 billion were withdrawn from USA money funds. This is the reason why strongest currency in Universe faced downturn

It was mainly because of the above mentioned subprime mortgage crisis investors around the world lost faith in US Economy and started withdrawing their investments from the country. This in turn reduced demand for USD and lead to strengthening of EURO at the same period.

Bibliography & Webliography

The Subprime Mortgage Crisis: An Overview of the Crisis and Potential Exposure (Research Paper) By Edward J. Kirk

http://www.imf.org/ http://europa.eu/index_en.htm http://en.wikipedia.org/ http://www.economist.com/ http://www.moneycontrol.com http://www.oanda.com

Thank You