This blog is in answer to a question from one of my school classmates (of 1979-80 vintage) who is based in the US and wanted to know where the Rupee /USD rate is headed.
Let me try to explain the mechanics in simple terms. This logic can be used to predict the long term movement of the conversion rate as well.
Two years back, in Q1 2010, the conversion rate was around Rs 44-45 to a dollar. Today, in Q2 2012, it is hovering around Rs 52 -53 to a dollar. The rupee has lost between 15 and 20% of value with respect to US dollar in the period.
In the last two years, India has had an inflation of around 10% per annum – which means over the last two years, the rupee has lost 20% of its purchasing power.
In the same period, the inflation in the US has been around 2% per annum – which means that the US dollar has lost 4% of its purchasing power in the same period.
What it means is that during the period Q1 2010 to Q1 2012, the US dollar has lost 4% of its value where as the Indian rupee has lost 20% of its value. Thus over this period, the Indian rupee has got devalued by about 16% when compared to the US dollar.
That explains the devaluation of the Indian rupee during this period.
Now my investment banker friends and students of economics may not like this simple explanation – but I believe that this logic is good enough to predict the conversion rate in the long term.So here is the simplified formula:
The annual rupee devaluation vis a vis US dollar = (Indian inflation rate) - (US inflation rate).
This formula can be used for long term predictions (one year and above) and not for short term predictions.
I predict that the INR/ USD conversion rate should be around Rs. 55.5 to a dollar in December 2012.