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Last updated on: April 23, 2013 21:39 IST

**If mangoes become dearer or appreciate in price, we don’t ask if the INR has appreciated or depreciated. We talk in terms of the value of mangoes, not INR. Likewise, in the forex market, we should now talk in terms of the value of dollars and not the INR, says Sonali Ranade**

In the normal course of business, talking about rupee appreciation or depreciation in India is fraught with risk. When does the rupee appreciate? Our intuitive sense tells us the rupee appreciates when it value relative to some foreign currency, usually the dollar, goes up. Conversely, the rupee depreciates when its value in terms of the dollar goes down. So far, so good.

Now the dollar was quoted INR 54 yesterday and is worth INR 55 today. Without reading below, try answering the following two questions. First, did the INR rate go up or down? Second, did the INR appreciate or depreciate?

Now that you have a sense of the confusion we have created in the forex markets, let us dig a little bit deeper to see where this confusion comes from and why the Reserve Bank and the financial media, including the venerable pink dailies that perpetuate this silly error, must do something about it.

The genesis of the confusion lies, as for most things naughty, in our socialist past. Back then we pretended the INR was the king and everybody wanted to buy it by paying in foreign exchange. So we had a system of “indirect quote” wherein the rate quoted was the amount of dollars one had to pay to a bank to buy INR in exchange. So if the going rate that day was 10, it meant you had to pay $10 to the bank to buy INR 100 in exchange.

Why this roundabout method of quoting a price for the dollar? Well, there are two reasons for it. One, ask the two questions we began with. Let us say the rate was 10 yesterday and is 11 today. Has the INR gone up or down? Yesterday we had to pay $10 to get INR 100 and today we have to pay $11 to buy the same INR 100. Clearly the INR is up in terms of the number [10 to 11 $s], and rate quoted.

So has the INR appreciated or depreciated? Clearly, the INR has appreciated because we have to pay more $ to buy it. So, in the old socialist era, since we bought or sold INR 100 or its multiples, and paid for them in dollars, our intuition worked fine. If the rate went up, the INR had appreciated and if the rate went down, the INR had depreciated. Further more, quoting for INR 100 made manual calculations a wee bit easier than the rival method of “direct quote”.

A system of “direct quotes” was ushered in by the Reserve Bank at the time of reforms in 1990-91 on the assumption that the market had grown sophisticated enough to understand and use them better 45 years after independence.

In the direct quotes system, a fixed unit of foreign currency is quoted in variable units of the home currency. In other words, now when you go to the bank, you are no longer required to pretend that you have gone there to buy or sell INR 100. Instead you ask for a dollar directly and the bank tells you how many INR you have to pay to get one dollar. Now you are buying and selling dollars directly from or to your bank.

The system of direct quotes treats the dollar like mangoes, or any other stuff, that you buy or sell for INR. If mangoes are INR 1000 per dozen, then you expect to pay INR 1000 to get a dozen of them. If the Dollar is INR 54 then you have to pay up INR 54 to get a dollar. If the mangoes are dearer tomorrow, you expect to pay more for them or in other words, the mangoes have appreciated in price. Likewise, if mangoes become cheaper, you expect to pay less in INR or you can say mangoes have depreciated in price.

So what happens when the $-INR rate quoted to you goes up from 54 yesterday to 55 today? Has the INR gone up or down? Has the INR appreciated or depreciated?

Confused still?

Note, the question itself is incorrect. We are now dealing in dollars which, we noted, are no different from mangoes. If mangoes become dearer or appreciate in price, we don’t ask if the INR has appreciated or depreciated. We talk in terms of the value of mangoes, not INR. Likewise, in the forex market, we should now talk in terms of the value of dollars and not the INR.

Coming back to our two questions, and noting that we are now talking in terms of dollars, we note the rate has gone up from INR 54 to INR 55. So rates are up. Has the dollar appreciated? Yes, because we have to pay INR 55 instead of INR54 for it. All work out correctly as our intuition tells us. But only so long as we talk in terms of buying and selling dollars and its appreciation or depreciation.

What if we insist on quoting direct rates for the dollar but talking in terms of the value of the INR? Well, that’s the prevailing confused system we have in the financial press that needs urgent correction.

We should always stick to talking in terms of the value of the dollar so that people intuitively know the direction of value of the dollar from its rate movement. The value of the INR moves in the opposite direction to the rates because it is the reciprocal of the rate quoted. That’s a little more difficult to grasp and the cause of much confusion that you see in the financial press which often quote a higher rate and scream INR depreciates!

If the rate you see is higher, it is because the dollar that has appreciated. If the rate is lower, it is the dollar that has depreciated. Just like in the case of mangoes, let the INR be constant. It is the price of dollars or mangoes that goes up or down, not the INR.

It should be that simple.

**Sonali Ranade is a trader in the international markets**