Q.“There exists a positive relation between foreign exchange rate and supply of foreign exchange.” Do you agree with the given statement ? Justify your answer with valid arguments.

Yes, I agree with the statement. The positive relationship between the foreign exchange rate and the supply of foreign exchange is a standard result in the foreign exchange market, derived from the behaviour of exporters and foreign investors.

When the exchange rate (domestic currency price of one unit of foreign currency, say ₹ per US dollar) rises, it means the domestic currency has depreciated. This makes domestic goods cheaper for foreigners. Consequently, exports rise, and foreign tourists find it cheaper to visit, both of which increase the supply of foreign currency in the domestic market. Similarly, a higher exchange rate makes domestic assets cheaper for foreign investors, encouraging more capital inflows, which also adds to the supply of foreign exchange.

The supply curve of foreign exchange is therefore upward sloping — as the exchange rate increases, the quantity supplied of foreign exchange increases. …

The relationship between the exchange rate and the supply of foreign exchange is one of the most intuitive ideas in international economics. Let’s first be clear on what we mean by “foreign exchange rate” here. In India, the exchange rate is usually expressed as the price of one unit of a foreign currency (say, the US dollar) in terms of the domestic currency (rupees). So if the rate rises from ₹70 per dollar to ₹80 per dollar, the rupee has depreciated — each dollar now costs more rupees.

Now, the supply of foreign exchange comes from two main sources: (1) foreigners buying our goods and services (exports), and (2) foreign investment and capital inflows (like FDI, FII, or remittances). The question is: does a higher exchange rate (a weaker rupee) increase this supply?

Why a higher exchange rate boosts supply — the export channel

When the rupee depreciates (exchange rate rises), Indian goods become cheaper for foreign buyers. A shirt that cost 10 US dollars when the dollar was at ₹70 now costs only about 8.75 US dollars if the rupee price stays the same. Foreigners buy more Indian exports. As export volumes rise, the total foreign exchange earned from exports increases — even if the per-unit dollar price falls slightly, the volume effect usually dominates. So the supply of dollars (or euros, yen, etc.) coming into India goes up.

The import substitution effect

A weaker rupee makes imports more expensive in rupees. This discourages imports, which means less foreign exchange is spent abroad. In other words, the demand for foreign exchange falls, but the supply side also benefits indirectly: when domestic industries replace imported goods with local production, the net outflow of foreign exchange reduces, effectively increasing the net supply available in the market.

The capital inflow channel

Foreign investors find Indian assets cheaper when the rupee is weak. A foreign portfolio investor can buy more Indian shares for the same amount of dollars. This attracts more foreign capital, adding to the supply of foreign exchange. Similarly, NRIs send more remittances in rupee terms when the exchange rate is high, though the dollar value of remittances may not change much — but the supply of dollars from remittances does increase as more rupees are converted. …