Inflation and Dollar Vs Currency Exchange Rates

Being in US, the dollar exchange rate and Indian inflation controls my savings range. I was trying to understand on what changes the Dollar Vs Rupee exchange rates and figured that many like me would have the same questions. Economics is about Demand Vs Supply. As most of you would be aware that world business is done in US dollars. Any change to the value of the US Dollar will affect Indian Economy too.

Statutory Warning: This blog may be very dry for lots of people as it is related to economics.

Inflation

Inflation usually refers to the general rise in the level of prices of goods and services over a period of time. India’s current inflation is 12%, which means for example if you have bought 100 pencils for 100 rupees a year back you have pay 112 rupees to get 100 pencils. Money is getting devalued, more money chasing less goods that is leading to price increase, Demand Vs Supply. Central Bank or RBI tries to control India’s inflation. How they do it??? They increase the interest rates and the percentage of money what the banks should hold. What happens if they increase the interest rates, it decreases the money in the market or money circulation in the market. Less Money and more goods, inflation will come down. Then there will be next question on how more money comes to the market, who else RBI prints and releases it to the market. We can think on why RBI can’t increase the rates to have Inflation under control. There is a flipside to it. How Inflation does controls the Dollar Vs Rupee Exchange Rates

Dollar Vs Rupee Exchange Rates

India allows FDI or Foreign Direct Investment, to see the list and percentage of investments allowed in different areas refer to the link << http://www.dipp.nic.in/manual/fdi_manual_11_2006.pdf>> . How does this control the Dollar Vs Rupee Exchange Rates? India is considered to be the economically booming country, lot of FDI’s are going into India for example from buying HUTCH and naming it as VODAFONE, NOKIA factory being opened in India, all those investments are done in through Rupees. Dollar has to be exchanged into rupees and then the investment has to be done. More Dollar --> Less Rupee in the market, Rupee will appreciate and that will affect the conversion rate. RBI controls the Dollar Vs Rupee Exchange Rates too, how do they do it either by increasing the interest rates to suck the excess rupee out of the market, which would decrease the value of rupee and then it inturn increases the value of the dollar trade with rupee. Why should RBI do it ??? To keep the Export market in India including IT industry to be profitable, more export a country does more economically strong it will become.

I am not sure on how clear I have written this blog, since it is a very very grey area for me too, I am trying to understand the economics behind these exchange rates.