Answer by Pratyush Rathore:
In order to understand what it means by a currency falling against another, we first need to understand how currencies work. (You asked for the answer in detail, don't blame me for the length, if you are not in mood for a long read, skip to the evaluation details section)
In the beginning, the universe was created and it is widely regarded as a bad move. But then, the planet Earth was designed to conceive the answer to the ultimate question. On this planet earth, various species evolved and humans, (who believe themselves to be the most intelligent species, but are actually the third), learned various life surviving skills like farming and making clothes and wheels and iphones. But there was a problem, since we could only do so much, we had to do 'Division of labor'.
Division of labor:
The problem with 'Division of labor' was how do you decide in what ratio do you divide the proceeds. How much wheat should a farmer exchange for how much rice and cotton? How much does the tailor get paid?
So, we came up with the Barter system, in which we fixed ratios of commodities and we traded commodities with each other.
Barter system worked for thousands of years, but then, there was a problem. Suppose, I am a broom maker. I want to buy an iphone. Apple doesn't want thousands of brooms for an iphone. Moreover, it would be really inconvenient for them to store thousands of brooms. So, they refuse to sell me the iphone unless I bring something which they want, but I don't own any patents.
Now, considering all the permutations and combinations, it is virtually impossible for me and apple to decide on something which I can supply and what they demand.
So, since I am an IITian I suggested something, which would revolutionize the world. No, not sex, something rare. (Objections duly noted). So, me and Steve (Jobs) sat one day and decided to use Gold as medium for our transactions. And since, Microsoft just copies Apple, all the corporations in the world started to believe in Gold.
(No, you are too serious, it wasn't me and Steve, somebody did it a few centuries back)
Now, it was difficult to carry Gold in your pocket. It was way too expensive to buy cigarettes and too small pieces were not manageable. So, somebody (no, not me) had this very interesting idea. He would manage the inventory of Gold and will give you papers with his signature promising the value of Gold. This papers can be used to purchase whatever you want and were equivalent to some specific amount of Gold. Everybody was happy.
In 1967 or sometime thereabout, the US Government realized that it didn't have a lot of Gold. But hey, it was the most powerful nation and how could anybody ask for their money back from the bully. They had to bypass the system. So, they said, we love you, but we won't promise you Gold. We just promise you a promise and we will call this promise a dollar.
It's an indefinite recursion, in which it is just the promise which is considered to be of value. All of sudden, gold was out of fashion and dollars were the new Elvis. Every other country just followed. (So, what you see on the 100 Rupees note is "I promise to pay the bearer a sum of 100 Rupees". What are 100 Rupees? A promise to pay the bearer 100 Rupees. 100 Rupees is a promise of itself.)
(Okay, no more jokes from now)
So, every country started operating in its own economy. But there was a problem. How do you compare a promise from India to a promise from the US? Basically, we are back to square one, barter between countries.
So, if a promise from the US is worth 1 unit, what can we buy from the US in that 1 unit. Like wise, a promise from India worth 1 unit should be measured in what can we buy from India in 1 unit. If the same quantity was to be bought from the US, what would be its price in terms of US promises? For the same good, the ratio of 'number of Indian promises' to the 'number of US promises' is called value of Indian promise(Rupee) in terms of US promise(Dollar).
(Slightly incorrect, in the sense that a coffee in India is comparatively much cheaper than in the US, but not going into detailed economics for now)
Why would a promise from the US be more expensive than a promise by India? Because, the earning of US, the difference between the goods it produces and the goods it consumes, is much better than the earnings of India.
It is also dependent upon the number of promises being made, technically known as currency in circulation.
Suppose, India is planning to sell 10000 broomsticks every year. And US is producing 10000 iphones.
Now, India sells those 10000 broomsticks to the US and keeps the promises from the US. The US buys them from India because they are cheaper to buy from India, otherwise it would ask more citizens to make them. Assuming 1$ per broomstick, US pays India $10000. A broomstick in India is worth 50 Rupees.
Now, India wants to buy 10000 iphones. But iphones are costly. US asks for $1000 per iphone. India doesn't have more than $10000. So, India asks the US to keep 10 million Indian Rupees instead of 10 million Dollars.
But, US says, what will I do of your Rupees. India says, "You can buy stuff from me later". US says, "I don't need a lot of stuff from you, you got to pay more if you want this loan". So, India says, "Okay, I will pay you 100 million Rupees". US goes through India's data and her own data. "No way", says US. We take price equal to 1000 broomsticks per iphone. So you have to pay 500 million Rupees.
Unwillingly, India has to pay them 500 million Rupees for 10000 iphones, and one USD is accepted to be equal to INR 50.
Having a cheap currency means you are taking more and producing less. Cheap currency isn't necessarily bad. China tries to keep its currency cheap so that it can export (by controlling circulation). But it is bad, if you are suffering from rising prices and are used to consuming foreign material. Because, it means price of foreign material will rise.
India's economies has really gone out of the line in the past decade. We have not been increasing production whereas we are consuming stuff like anything. So, the rest of the world doesn't want to feed us for free. That is why, the Indian rupee has been declining consistently for the last few years.
What happened last month:
The US Government said that it would increase the circulation of Dollars by printing more money, thus making Dollar cheaper. But, last month it came back and said that there is no need to print more Dollars. So, the market now had to consider INR to be cheaper as Dollars are rarer.
After that, the market picked up trend and the Rupee got battered. It might still get a bit more beating before it stabilizes, that's how the markets work.
What happened in the last month, is just a rude wake-up call to us. Mostly the rupee will get some more strength in short term, but if we don't do something about long term problems now, we might face a *BIG* problem in the years to come.
From the comments:
But can u explain more on the ending part..
U.S decided to print money so how did it affect Indian economy so much ?
US decided not to print money means US Dollars are less in circulation. Therefore, purchasing power of Dollar is going to increase that is to say things are going to become cheaper in the US. So, it had the effect of Dollar rising against all currencies, not just India.
(For example, Euro was trading at 1.34 on 18th of June, was somewhere around 1.30 marks on the 25th, did the European economy go down by 3.5% in just one week? No, right?)
Imagine if everybody had ten lakh rupees, will anybody work for you for 3000 per month? No, right? People would want more payment since they can make those 3000 from ten lakhs very easily, so the price of manufacturing would go up, the cost of living would go up and hence prices would go up. US did the opposite, people have lesser dollars now, so things would become cheaper, hence rupee would also become cheaper.
What we are seeing is the domino effect in the markets, the rupee got battered ( 3-4% is expected ), the trend sharks in the bonds market, ie the people who just follow the trend and execute followed the suit and things compounded.
Some time back, say two years or so, we used to talk about change in basis points, that is 0.01 of a percent, now we talk about change in percentage in currencies, which is a very bad news. Because, it means we don't know what the value of our currency is.
The problem with Rupee isn't the one in the last month, but the one we have been seeing the last year or two. Rupee was trading at 44 in 2011 August. After that in 22 months, we have lost 35% of its value till date. That is huge and that is indicative that something is seriously wrong with the economy (which you can see from the rising prices). What happened in the last month, was just a wake up call, an expensive one though.