Appreciation and depreciation of currency

As per my post on basics of appreciation and depreciation of rupee, we saw what appreciation and depreciation of rupee means. Now this post will help us to understand what causes appreciation and depreciation of a currency and its effects.

As from our previous example, we assume that there are 2 countries India and USA, and there is flexible exchange rate regime. Therefore value of currency of each country in terms of the other depends on the demand and supply of their currencies. It is in the foreign exchange market that exchange rate among different countries is determined. It is a market in which currencies of various countries are converted into each other or exchanged for each other. In our case, Indians sell rupees to buy US dollar and the Americans will sell dollars in exchange for rupees.

Demand for dollar
Now demand for dollar by Indians arises due to the following:
· The Indian individuals, firms or government who import goods from USA into India, as they need to pay for goods and services imported.
· The Indian individuals travelling and studying in USA would require to meet their travel expenses and education expenses.
· The Indians who want to invest in equity shares and bonds of the US companies and other financial instruments.
· The Indian firms who want to invest directly in building factories, sales facilities, shops in USA.

Supply of dollar
Let’s see what causes supply of dollars in exchange market:
· The individual firms and government which export Indian goods to USA will earn dollar from American residents who would buy Indian goods imported into USA and pay their price in dollar.
· Americans who travel to India and use the services of Indian transport, hotels etc .will also supply dollars to be converted into rupees for meeting these expenses.
· American firms and individuals who want to buy assests in India , such as bonds and equity shares of Indian companies or wish to make loans to Indian individual and firms will also supply dollars.
Equilibrium is establish in foreign exchange markets by simple demand and supply of currencies…..when
Demand= supply, then foreign exchange market is said to be in equilibrium. The equilibrium in the foreign exchange market will be disturbed if some changes occur in the underlying factors that determine the demand for and supply of foreign exchange.


Appreciation of rupee
For e.g., if there is in increase in incomes of American people due to boom conditions in the US economy, it will affect the equilibrium rate of exchange. The increase in incomes of the people of USA will lead to increase in demand for imported goods those of India. Now this would lead to increase in supply of dollars, which would in turn lower the price of dollars in the foreign exchange market by simple theory of demand and supply, as now there will be excess supply of dollars. This implies that increase in imports by USA from India leading to more exports from India will cause dollar to depreciate and Indian rupee to appreciate.

Depreciation of rupee
On the other hand if due to increase in incomes of Indian people causing arise in demand for American consumer goods or there is picking up of industrial activity in India requiring more imports of material, machines equipments and other capital goods from USA the Indian imports from USA will increase. The increase in imports from USA by India will have to be paid in dollars causing demand for dollars to increase. This will cause disequilibrium in the foreign exchange market, as with increase in demand for dollars, there will emerge excess demand for dollar which will push up the price of dollar and this rise in price of dollars in terms of rupees implies depreciation of value of rupee.
This how the foreign exchange market works……………..for more details you can refer to books like
· Dornbush R. and S. Fisher., Macroeconomics
· Mankiw, N.G., Macroeconomics
· Froyen R.T., Macroeconomics,

Biofuel Policy of India

The national government released its first ever national biofuel policy which was most notable for its mandate that 20% of all diesel demand should be met using plant based rather than fossil based diesel by 2017. The policy also stipulated that 10% of all gasoline demand should be met using ethanol compared with current mandate of 5%.
The policy also suggested removing all central taxes on biodiesel and according declared goods status to biofuels that would ensure a uniform 4% sales tax on the product across states.
With the mounting inflation it seems that root cause of it is use of food stocks in creation of biofuels. But when we analyze costs and benefits of creation biofuels, the picture turns out to be different.
The assumption that biofuel production will lead to crowding out of food production is also misleading. Jatropha plant which is the main source of production of biodiesel in India is a hardy plant which can grow on land on which traditional food crops cannot grow, which means that arable land need not to be sacrificed for fuel production. In addition to this jatropha production is estimated to utilize less than 1% of water required for traditional food crops. Similar to this other crops which are used in production of biodiesel have low inputs, meaning that even large-scale production of biodiesel will not result in a significant diversion of scare water resources from food production.


The Jatropha advantage
Jatropha is an eternal hardy shrub which can survive in arid and semi arid tropics. It grows wild in many areas of India and even thrives on infertile soil. This makes it an ideal feedstock for, biodiesel as India has more than 170 million hectares of wasteland which need revegetation. Since jatraopha is water efficient and widely adaptable, large scale jatropha plantations require for the biodiesel industry could lead to generation of these wastelands.
The yield of Jatropha oil is quite high, ranging from 1 to 5 tonnes/ ha depending upon the soil conditions and rain fall, and oil can be extracted from seeds starting from the second year. Jatropha biodiesel projects can also help in rural developments by introducing new employment opportunities in agricultural and small and medium industrial sectors. Assimilation of atmospheric carbon, to the extent of approximately 10 tonnes CO2 per hectare, can be realized by Jatropha plantations! Since India is a developing country, this can be traded under the Clean Development Mechanism (CDM). Article 12 of Kyoto protocol specifies that developing countries can benefit from CDM projects resulting in "certified emission reductions" (CERs) and that industrialized countries may use CERs to comply with their quantified emission reduction commitments. This is an additional economic advantage favoring Jatropha biodiesel projects in India.

Encouragement by government
The government is making efforts not to encourage biofuels at the cost of food grain production. The government has decided that no food grain or oilseed should be used for producing biofuels. The The idea is to prevent a repeat of the American experience where diversion of corn for ethanol production is being blamed for foodgrain price spurt across the globe. Therefore, use of even coarse grains for biofuel production would not be allowed. In the case of sugarcane too, there are concerns that focus on ethanol would lead to lower production of sugar.
Only wasteland is to be used for growing biofuel producing plants such as jathropa. While biofuel production is yet to catch up, there is growing concern over diversion of farm land pushing up price of foodgrains. The risk cannot be afforded at a time when Indian entities are looking at purchasing farmland in south America, Africa and Canada to grow pulses and oilseeds. Land has become a scare resource and disputes are raging in various parts of the country over use of farmland for other purposes, including industrial development.
Recently, some companies have started cultivation of biofuel crop on wasteland and degraded forest land. BP, IOC, BPCL, Reliance and IKF Technologies have already rolled out plantations in about 3 lakh hectares of wasteland spread across the country. The National Policy on Biofuels has set an indicative target of 20% blending of biofuel in both petrol and diesel across the country by 2017.

Advantages of Biofuels for India

Decreased emissions of harmful pollutants: Ethanol and biodiesel contain oxygenated compounds containing no sulphur. These fuels do not produce sulphur oxides which lead to acid rain formation. Sulphur is removed from petrol and diesel by a process called hydro-desulphurization. This process causes loss in lubricity which has to be rectified by producing an additive. Biodiesel has natural lubricity and thus no lubricity enhancing additive is required.
Condensation in green house gas emissions: The net CO2 emission of burning a biofuel like ethanol is zero since the CO2 emitted on combustion is equal to that absorbed from the atmosphere by photosynthesis during the growth of a plant (sugarcane) used to manufacture ethanol. Biofuel contribute significantly to climate change by reducing CO2 emissions. Biodiesel projects can qualify as CDM projects and thus can fetch in additional income through the sale of certified emissions reductions.

Employment generation: Biofuel industry in future can become major source of employment. The investment in the ethanol industry per job created is $ 11000, which is significantly less than $220,000 per job in petroleum sector. In India sugar industry which is the backbone of ethanol production is the biggest agro industry in the country. The sugar industry is the source of livelihood for about 45 million of farmers and their dependents comprising 7.5% of rural population. Another half a million people are employed as semi-skilled laborers in sugar cultivation. The first phase of the National Biodiesel Mission demonstration project will generate employment of 127.6 million person days in plantation by 2007. On a sustained basis, the program will create 36.8 million person days in seed collection and 3,680 person years for running the seed collection and oil-extraction centres.
Energy security and decrased dependence on oil imports: India ranks sixth in world in terms of energy demand. India‘s domestic crude oil production only satisfies about 25% of this consumption. Dependence on imported fuel leaves many countries vulnerable to possible disruption in supplies, which leads to physical hardships and economic burdens. The volatility of oil prices poses great risks for world’s economic and political stability, with unusually dramatic effects on energy importing developing nations. Renewable energy, including biofuels can help to diversify energy supply and energy security.

Improved social well being: A large part of population, mostly in rural areas does not have access to energy services. The increased use of renewable (mainly biofuels) in rural areas is closely linked to poverty reductions because greater access to energy services can:
· Improve access to pumped drinking water. Potable water can reduce hunger by allowing for cooked food (95% of food needs cooking).
· Reduce the time spent by women and children on basic survival activities (gathering firewood, fetching water, cooking etc).
· Allow lightening which increases security and enable night time use of educational media and communication at school and home.
· Reduce indoor pollution caused by firewood use, together with reduction in deforestation.

Lack of access to affordable energy services among the rural poor seriously affects their chances of benefiting from economic development and improved living standards. Women, older people and children suffer disproportionately because of their relative dependence on traditional fuels and their exposure to smoke from cooking, the main cause of respiratory diseases. Electricity through transmission lines to many rural areas is unlikely to happen in the near future, so access to modern decentralized small-scale energy technologies, particularly renewables (including biofuels), are an important element for effective poverty alleviation policies. A programme that develops energy from raw material grown in rural areas will go a long way in providing energy security to the rural people.

Biofuel Industry

Biofuel is any fuel that is derived from biomass. It is a renewable source unlike other natural resources, such as petroleum, coal and nuclear fuels.

Overview of the industry
With the prices of crude oil surging up to $ 150 barrel, biofuels have essential role to play in meeting energy needs for India. Most of the energy requirements are at present satisfied by fossil fuels – coal, petroleum based products and natural gas. Domestic production of crude oil can only fulfill 25-30% of national consumption and extensive demand for oil has forced India to depend on other countries for oil. This has increased risk exposure of the country to the high price of the crude oil in the international market.
India started on with its biofuel journey in 2003 with an impressive growth. Ethanol and biodiesel are gaining acceptance worldwide as good substitutes for oil in the transportation sector.
· Ethanol is currently produced in India by the fermentation of sugarcane molasses is an excellent biofuel and can be blended with petrol.
· Likewise, biodiesel which can be manufactured by the transesterification of vegetable oil can be blended with diesel to reduce the consumption of diesel from petroleum.
· Brazil uses pure ethanol in about 20 per cent of their vehicles and a 22 to 26 per cent ethanol-petrol blend in the rest of their vehicles.
· The United States and Australia use a 10 per cent ethanol blend.
· With a normal production rate of 1,900 million litres a year, India is the world’s fourth largest producer of ethanol after Brazil, the United States and China.
· Beginning 1 January 2003, the Government of India mandated the use of a 5 per cent ethanol blend in petrol sold in nine sugarcane producing states. The Government will expand the 5 per cent ethanol mandate to the rest of the country in phased manner.

Biofuels offer a number of environmental, social, and economic advantages, including lower emissions of harmful pollutants; decreased greenhouse gas emissions; increased employment; increased energy security, especially in rural areas; decreased dependence on oil imports; and good fuel properties for vehicles.

Key findings
· Ethanol dominates the world biofuel market and its production is expected to grow at a CAGR of around 6% during 2008-2017.
· Worldwide biodiesel production is expected to grow at a CAGR of over 5% from 2008 to 2017.
· Ethanol production of India is likely to attain a CAGR of slightly over 2% during the period 2008-2017.
· Increased ethanol use is expected to supersede the production during the forecasted period. Domestic ethanol consumption in India is projected to expand at a CAGR of around 6.5% during 2008–2017.
· India’s total biodiesel requirement is projected to grow to 3.6
· Million Metric Tons in 2011-12, with the positive performance of the domestic automobile industry.
· Similar to Brazil and the US, the Indian automobile industry has huge potential for the flex-fuel vehicles.