Currency Market Analysis Assignment

This Currency Market Analysis  Assignment report described optimized methods for  currency analysis.

Currency Market Analysis – Introduction

Currency or money is the most crucial elements of economic science. Properly operated, monetary system is the life blood of the circular flows of income and expenditure. On the other hand a malfunctioning monetary system will lead to serve fluctuations in the economy’s level of output, employment and prices. Currency which is chosen for this assignment is INR or Indian national rupees.

Currency Market Analysis Assignment
Currency Market Analysis

Currency Analysis

Currency analysis of a country is a very complicated process in which we need to analyze the current status of country’s economy, its past economic performance; it’s trading with rest of world, country’s balance of payment, its import & export status etc. we have two analyzing methods to evaluate currencies and their values.

Currency Market Analysis Assignment
Currency Issue in India

These are:-

  • Fundamental Analysis
  • Technical Analysis

Fundamental Analysis

To understand the market movements, fundamental analysis plays an important role of learning the market trends. In the short term, the results do not always go along with the fundamental analysis. But in the long term, currencies always move along with this analysis. This analysis will serve you to interpret the reasons behind movements.

Fundamental analysis is a method of valuating an asset that takes into account its demand, supply, past performance, earnings and other fundamental measures of the country. It based on some economic solution reports like forex report, employment report, production report etc. These reports are used as economic indicators (Epstein, 2007).

Economic Indicator

An economic indicator represents financial data of the economy. It depicts the trends of economic activities which influence currency’s value. Some economic indicators of country are

Gross Domestic Product (GDP)

GDP is defined as the monetary value of all the goods and services produced by an economy over a specified period generally a year. It influences the level of employment, the level of output and people’s standard of living. This statistics provide important background information on which the government can base its decisions. It is used as a means of comparing the economic performance of different countries which is useful to describe currency exchange rate. GDP also indicates changes in the economic growth of a country.

These are most recent GDP records of India:

Year 2008 2009 2010 2011 2012
GDP (%) 3.9 8.2 9.6 6.9 5.5(projected)

Inflation

Inflation is defined as an increment in general level of prices of consumer goods and services for a period of time. Wholesale Price Index (WPI) and Consumer Price Index (CPI) are two indices which represent the rate of inflation. The inflation rate means the rate of change of the either indices. The rate of inflation indicates the rate at which purchasing power of money is being eroded. In July, 2008, the Indian Inflation Rate had surpassed 11% level which was the highest rate recorded in last 16 years. Government of India has failed to take effective measure to control inflation by changing its monetary policies (Datt and  Sundharam, 2011).

Year 2008 2009 2010 2011 2012
Inflation Rate (%) 9.7 14.96 9.47 6.49 10.16

Production

It is a common practice to divide the totality of economic activities into three broad groups viz ‘Agriculture and related activities’, ‘Industry’ and ‘Service’. Changes in industrial production are reported in the form of changes in an index number called Index of Industrial Production (IIP). This is a representative figure which measures industrial marketing activities in the economy. It depicts percentage growth of industrial production. Country’s production level affects country’s GDP and import-export which are very crucial in currency valuation.

Currency Market Analysis Assignment

Industrial Production Growth Rate

Year 2008 2009 2010 2011
Rate (%) 4.8 9.3 9.7 4.8

Imports and Exports

Import – a good or service consumed in one country which has been bought from another country. If imports go down then the supply of local currency will decrease and hence, increase the value of domestic currency. Export – an economy produces a good or service and sells to another economy which is the actual consumer of that good or service. If other countries put higher trade barriers on exports of a country then it will decrease the demand for its exports which leads a decrement in value of currency.  ‘Higher the exports, higher the demand of domestic currency and hence, increase the value of domestic currency.’

If imports of a country are higher than its exports then demand of local currency will decrease on international business market, which decreases its value. Demand and supply of local currency will decide its exchange rate with other currencies in international business market (Levy-Yeyati, 2005).

India’s imports-exports in Billion $

Year 2007 2008 2009 2010 2011
Imports 187.9 305.5 274.3 327 461.4
Exports 112 176.4 168.2 201 299.4

 India’s Trade Partners

India’s five major trade partners in 2011-

Import partners- China 12.1%, UAE 8.3%, Saudi Arabia 5.8%, US 5.1%, Switzerland 4.7%

Export Partners- UAE 13%, US 11.4%, China 6.3%, Singapore 5.3%

These trade partners are very strong economy in comparison to India which have negative impact on India’s currency exchange rate

Interest Rates

Every country’s central bank determines overnight lending rate for currency. If inflation rate is rising very high then a central bank may raise the interest rate to chill the economy. In contrast, if economy activities become slow, a central bank reduces interest rates to accelerate growth of economy. In the lower interest rates scenario, the value of currency will start depreciating because of carry trade. In carry trade, trader sells a currency with a low interest rate and buys with a high interest.

Employment

The rate of unemployment is simply the fraction or percentage of workforce that has no gainful employment. This is a key economic indicator. If a country has high unemployment rate that means that country’s economy is not able to provide jobs for living. And it depreciates the value of currency of the country. Unemployment rate:-

Year 2008 2009 2010 2011
Rate (%) 6.8 10.7 10.9 9.8

Business Cycle

Economic growth is not a continuous process. Upswings and downswings are of varying duration and intensity and are referred to as ‘cycles’. Government attempts to smooth out these fluctuations with the use of monetary and fiscal policies. During the growth phase of cycle, economic factors support risk, and with strong fundamentals demand of domestic will increase and in decline phase currency lose its value.

Political Environment

Recently, India got third position on corruption rating which impact a bad impression on foreign investors. Corruption scandals have reinforced a negative perception on the rest of the world. It directly affects its import and exports and confidence of foreign investors, which leads to depreciation in value of currency.

Balance of Payment (BOP)

All countries have economic transactions with other countries. These consist of import and export of goods and services, official and private gifts and donations, lending and borrowing abroad and investment abroad in financial and physical assets. The Balance of Payment (BoP) account is the summery of the flow of economic transactions between the residents of a country and the rest of the world during a given time period. BoP of a country is like the balance sheet of a company (Heijdra, 2002).

Trade Balance

Trade balance refers to excess of merchandise exports over merchandise imports. Thus ‘trade deficit’ implies that imports of goods exceed exports of goods. Trade balance would be an important indicator of income and outgo. Fluctuations in trade balance points towards changes in country’s production and exports. ‘Terms of Trade’ is another factor that affects country’s trade balance.  It is a ratio of exports price to imports price. Increment in this ratio shows a rise in exports price of the country than its imports.

Current Account Balance

The current account balance reflects net inflow of imports, exports and investment in abroad over a specified period generally a year. It shows the difference between savings and investment of an economy at its domestic level whereas in GDP, we calculate monetary value of all domestic goods and services. A positive sign of current account indicates that economy’s savings are invested abroad whereas a negative sign shows that domestic financial requirements are filled by foreign investors. The current account balance indicates country’s net assets in international market (Dwivedi, 2001).

Indian Current Account Balance

Year 2007 2008 2009 2010
Billion ($) -8.076 -30.97 -25.92 -51.78

(Import Export Data, 2011).

Capital Account Balance

The capital account records all public and private capital transactions. Increment (decrement) of the country’s foreign financial assets is recorded in the capital account as debits (credits) vice versa for liabilities. The balance in the capital account reflects the source of finance for balancing of current account. In case of BoP deficit, total balance of current account and capital account is negative. Negative balance is covered with surplus taken from reserve account. It will reduce foreign exchange and gold reserves. If adequate care is taken to understand and interpret the data provided by the BoP, it can prove a useful source of information to estimate the direction that a particular exchange rate is expected to take. At the same time, BoP data cannot be considered in isolation for predicting movement in the exchange rate, other economic indicators are equally important (Blanchard, 2011).

Purchasing  Power Parity (PPP)

The purchasing power parity (PPP) is an economic theory. It shows the price level difference between two countries. It is a ratio of the purchasing power of a currency in one country to the same in another country. The Value of goods and services is taken in calculation of GDP at the price dominating in US at the point of time. This is the most preferable measure by economist looking for per capita income of a country and to compare standard of living of population with other countries.

Year 2007 2008 2009 2010 2011
GDP at PPP 2,966 3,297 3,680 4,060 4,515

GDP (at Purchasing Power Parity) (Billion $)

This theory takes some assumptions like the absence of transaction costs, duties and other controls, identical goods should have the same price in different countries when expressed in same currency. Purchasing Power Parity describes the behaviour of exchange rates of currencies in long term. It takes many years in account typical 4-10 year’s time horizon. With the help of PPP, we can calculate how much currency is overvalued or undervalued (Srinivasan, 2002).

Interest Rate Parity

Interest rate parity states premium of foreign exchange risk is equal to cost of money (rate of return or cost of borrowing money) over different currencies. It plays a significant role for determining future and spot exchange rate in foreign exchange markets.

Technical Analysis

Technical analysis is a form of market analysis that studies demand and supply for currencies based on trading volume and price studies. Using charts and modelling techniques, technicians attempt to identify the price trends in a market. Technical analysis studies the past price history and makes future prediction for exchange rate. It uses many different methods and forms to calculate future exchange rates.

Technical indicator is a very common method for technical analysis. It is a graphical representation of past exchange rates over a period of time. MACD is famous example of technical indicator which is used in first forex trade tutorial.

While fundamental analysis serve as a guide to an investor in stock selection, technical analysis serves as a guide to decide on the timing of a stock purchase/sale. Fundamental analysis is based on the financial statements; technical analysis is independent of these financial statements (Kieso, Weygandt  & Warfield, 2007).

Recommendations for Expected Exchange Rate

After studying the various factors that affects exchange rate, the forecast for future is shown in green. The growth and performance of Indian economy on international level is forecasted by various economic parameters (Rajani, 2011). These economic indicators are not in favourable condition to strengthen the Rupee against US dollar. Currency exchange rate is expected to increase in near future. GDP growth rate is going down in comparison to last year, figure shows that inflation rate is going out of control which decrease purchasing power of Rupee, exports are falling continuous while imports chart is going up which decrease demand of Rupee, industrial production forecast for this year is not enough to control this fall. Indian economy is facing current account deficit. A deficit on current account means that domestic saving is insufficient to fund domestic investment, resulting in import of saving from abroad which increase its foreign liabilities. If oil price continuous rises or Indian economy loose the confidence of foreign investors then it weaken the Rupee against US Dollar (Panagariya, 2008).

Conclusion

Currency or money is one of the truly great inventions of man. Investors need to adopt appropriate currency analysis strategy before investment in currency commodity. There are two methods available for analysis- 1) Fundamental Analysis 2) Technical Analysis. We used fundamental analysis for currency prediction. Fundamental analysis based on economic, political and social parameters that push demand and supply. In technical analysis, traders use charts and trends of past history to predict future price.   There are various economic indicators available to study to predict future exchange rate for example GDP, Current Account balance, government political environment, imports-exports, industrial production, business cycle etc. We studied many indicators in fundamental analysis to forecast exchange rate of Rupee against US dollar. Some indicators are always valuable in fundamental analysis and some other will less important for some time. For example, if a country is experiencing solid growth and inflation than the Consumer Price Index will be consider as a most important indicator by the market.

Currency Market Analysis Assignment

The Indian Economy is the fourth largest economy in terms of purchasing power parity. India is one of most desirable investment destination for foreign investors but its environment is not favourable for economy growth for long term due to down signs of growth indicators. This unfavourable environment leads to negative perception for investment in India. All economic indicators, based on past history, analyze present performance of an economy and allow us to predict future growth prospects.

References

  • Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2007). Intermediate Accounting (12th ed.). Hoboken, NJ: John Wiley & Sons, p. 1320 ISBN 0-471-74955-9
  • Datt, R.; Sundharam, M. (2011). Indian Economy. New Delhi: S. Chand Group. p. 976. ISBN 978-81-219-0298-4.
  • Panagariya, A. (2008). India: The Emerging Giant. Oxford University Press. p. 514. ISBN 978-0-19-531503-5.
  • Levy-Yeyati, E. (2005) “Classifying Exchange Rate Regimes: Deeds vs. Words”. European Economic Review 49 (6): 1603–1635.
  • Import Export Data, (2011) “Imports and Exports Databank”. Ministry of Commerce and Industry, Government of India. Retrieved 2012-10-27 available on; http://commerce.nic.in/eidb/default.asp