Dollar vs Rupee: What Drives the USDINR Exchange Rate?

August 19th showed the Rupee strengthened to around ₹87.02 per Dollar, marking a steady recovery from its recent low of nearly ₹87.98 against Dollar about two weeks earlier as per Google Finance.

With the help of this blog we will explore why the Indian Rupee to USD suffered at first, what reversed its slide, how US Dollar to Indian Rupee shifts affect Indian investments, and we will also try to demystify how economic models like Purchasing Power Parity (PPP) and Interest Rate Parity (IRP) can explain currency moves in the long run.

Why Did the Dollar to Rupee Rate Hit Its Low in Early August?

• Importer Demand and Oil Costs: Heavy Dollar demand from oil companies and importers put pressure on the Rupee, sending the Dollar to INR near record lows of ₹87.65 and even ₹87.88 per Dollar on August 5th as per Google Finance.
• Trade Tensions and Tariffs: U.S. tariff threats on Indian goods and worries over India’s Russian oil imports hurt sentiment, adding weakness to the USDINR.
• RBI Intervention Was Limited: The RBI tried to stabilize the Rupee but acted cautiously, which allowed the currency to fall further.

Why Is the Rupee Now Recovering?

• Easing Tariff Risks and Geopolitical Calm: Reduced chances of new U.S. tariffs, helped by the Trump-Putin meeting and possible sanction delays, restored confidence in the Rupee.
• GST Reform Optimism: Plans for major GST cuts lifted market sentiment, fueled a stock market rally, and supported the Rupee.
• S&P Rating Upgrade: S&P raised India’s credit rating from “BBB-” to “BBB,” boosting foreign investor confidence in the INR.
• Improved FX Reserves and Intervention Strategy: Rising forex reserves, aided by gold revaluation and a softer Dollar, strengthened the RBI’s ability to cushion the Rupee.

What Happens to Indian Investments in Dollars When USDINR Moves?

Imagine you’re an Indian investor using the INDmoney app to invest in companies listed in the U.S. which are denominated in U.S. Dollars. Here’s what matters:

• When the Rupee Weakens (Dollar Appreciates): The value of US investments rises when converted back to INR. For example, if you invested when the 1 USD to INR rate was 80, and the Rupee later weakened to 88, the same $1,000 in US investments will fetch ₹88,000 instead of ₹80,000 back in India.
• When the Rupee Strengthens (Dollar Falls): Your US assets lose value in Rupee terms. Using the above example, if the rate moves from 88 back to 84, your $1,000 will now fetch only ₹84,000.

So a recovering US Dollar to Indian Rupee means better value when converting your U.S. investments back to Rupees.

It’s also very crucial to factor in currency conversion charges and platform fees when transferring INR to USD and vice versa as they impact your net returns. 

For investors, it helps to remember that short-term global currency rate moves are often unpredictable. But over the long run, concepts like PPP and IRP offer useful guidance. Keeping these in mind allows you to plan investments with a clearer view of where the Rupee and Dollar could head in the future.

Demystifying PPP and IRP

Purchasing Power Parity (PPP)

Imagine you order a samosa on Zomato in Delhi for ₹20. Now, the same samosa in New York (say at an Indian café) costs $2. If 1 USD to INR is ₹87, then that New York samosa is ₹174 in Indian terms. Clearly, something’s off. Over time, the exchange rate tends to adjust so that the “samosa gap” narrows.

But the point is, is there a way to forecast USDINR or any exchange rate’s trajectory in the long term for normal investors? Absolutely, there is, the simple formula goes like:

Where:

• ERt = Future Exchange Rate
• ER0 = Current Exchange Rate
• πIN​ = Inflation (India)
• πUS​ = Inflation (US)
• n = Years

So if we want to forecast exchange rate of USDINR 10 years ahead with the help of PPP formula, let us take year end data of 2024, where;

• India CPI: 5.22% (Source: MoSPI) 
• US CPI: 2.9% (Source: BLS) 
• Exchange rate as of 31st Dec 2024: 85.5330 (Source: Google Finance)

Exchange Rate 2034 = 106.8964

PPP works in the long run because inflation differences between economies gradually show up in exchange rates. 

Interest Rate Parity (IRP)

Say an Indian bank offers 6% on a fixed deposit, while a US bank offers only 3%. At first glance, it looks like keeping money in India is better. But IRP says the Rupee might weaken just enough in the future that both end up giving you roughly the same return when converted back to USD to INR.

Similar to PPP, there indeed is a way to forecast USDINR rates in the long run with the help of IRP, the formula goes like:

Where:

• SRt​ = Future spot rate after t years
• SR0​ = Current spot rate
• iIN​ = Interest rate in India
• iUS​ = Interest rate in the US
• t = Years

So if we want to forecast exchange rate of USDINR 10 years ahead with the help of IRP formula, let us take year end data of 2024, where;

• India Rate: 6.5% (Source: CCIL)
• US Rate: 4.5% (Source: Federal Reserve)
• Spot rate as of 31st Dec 2024: 85.5330 (Source: Google Finance)

Spot Rate 2034 = 103.3872

IRP works over longer horizons when markets are stable. In the short-term; speculators, central banks, and unexpected news cause deviations in it.

Why IRP, PPP Are Not Ideal for Short-Term USDINR Moves?

IRP and PPP work well for long-term currency forecasting, but short-term exchange rates are often swayed by factors beyond these models, such as:

• Geopolitical events: Wars, elections, or policy shifts.
• Capital flows: Sudden foreign inflows or outflows.
• Central bank actions: RBI or Fed interventions in currency markets.
• Investor sentiment: Market psychology and speculation.

These real-world forces can push USDINR far from the fair values suggested by theory.

The exchange rate of 1 USD to INR is more than just numbers, it’s the pulse of investor sentiment, policy, and global trade.

By looking beyond just daily swings in USDINR, and understanding the broader forces like tariff risk, reforms, rating actions, PPP and IRP, you as an rational informed investor can get a clearer picture of where the dollar vs rupee is headed.

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