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Economics/Riyal Currency Fluctuation in Middle East Countries.

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QUESTION: Dear Prof Eklimur

http://en.wikipedia.org/wiki/Riyal
http://hemoneyconverter.com/INR/SAR.aspx
http://www.currency.me.uk/convert/sar/inr
http://www.prokerala.com/news/finance/currency.php?from=OMR&to=INR
http://www.xe.com/currencyconverter/convert/?Amount=1&From=INR&To=QAR
http://en.wikipedia.org/wiki/Saudi_riyal

What could be the reasons for the Riyal Currency Rate Fluctuation in Middle East Countries ?.

1 Omani Riyal = Rs 140.
1 Saudi Riyal = Rs 14.48.
1 Qatari Riyal = Rs 14.9.

What are the Factors contributing to this fluctuations ?.

Awaiting your reply,

Thanks & Regards,
Prashant S Akerkar

ANSWER: Hi Prashant,

Thank you for looking forward to my help. I am sorry that, because I was a little busy, I couldn’t answer to your question earlier. I hope I am going to address your problem to your expectation.

The factors behind-currency rate fluctuations in the Middle East are multi-faceted in nature.
First, there is a role played by historical dynamics. Though – through local uprisings, invasions, changing demarcations and foreign interventions –the area we today call Middle East has evolved into modern independent countries with independent financial systems, these nations have a unique history of financial ties to the Indian rupee as currency.

Second, coming historically under one encompassing canopy of British influence as these nations are, these Middle East countries over the last half a century or so have absorbed strands of financial thrusts from across continents against a modern globalized setting.

Third, the new financial world as we see today exerts its financial influence in the Middle East against a backdrop of entrenched socio-cultural and economic ethos. Therefore, the financial milieus of the Middle East are governed by a rare amalgam of globalization and conservatism. To be precise, these chunks of landmass that comprise the Middle East of today existed in slightly different shapes with different geographical boundaries under diverse ruling circumstances, at a time when the ramifications of financial authority once exerted forcefully by the East India Company were still at play. Over time, however, with globalization taking hold on the heels of downfall of British Raj and rise of American capitalism and with Oriental wealth indexes taking drastic reshuffle on the heels of new discoveries of oil sources and unprecedented application of oil in rapid industrialization, these Middle East countries found themselves in ferment. There indeed were great financial changes wrought against propelling economic advances together with impeding social inertia.

Hence, on Middle East financial turf, historical die-hard financial conditions and modern globalized international circumstances play a major role in alignment of currency exchange rates among these nations. An explanation is in order.

One, these countries kept to the Indian rupee for quite some time. Then there was the changeover. That changeover, however, came about at different times in those different countries. As a result, their currencies were receiving exchange values differently – directly though the world currency and indirectly through the Indian currency. Over time, they all converged to one system of exchange-rate evaluations, but the differences once entrenched persisted. Following is a quick historical rundown.

Before 1940 Muscat and Oman used the Indian rupee and the Thaler, with rupees circulating on the coast and Thaler in the interior. Thaler was valued at 230 paisa, with 64 paisa equal to the rupee. In 1970, the rial Saidi  was made the currency of Oman. It was equal to the British pound and replaced the Gulf rupee at a rate of approximately 21 rupees to the rial. The rial Omani replaced the rial Saidi at par in 1973. The currency name was altered owing to the regime change in 1970 and the subsequent change of the country's name.The Indian rupee remained the de facto currency of the Trucial states as well as the other Persian Gulf states such as Qatar, Bahrain and Oman until these countries introduced their own currencies in 1969, after the great devaluation of the Indian rupee. Qatar used the Indian rupee as currency, in the form of Gulf rupees. When India devalued the rupee in 1966, Qatar and other states chose to introduce their own currencies. Qatar also began issuing the Qatari riyal separate from Dubai on in 1973 after Dubai’s entrance into the United Arab Emirates.

Two, some of these countries got rich quick –too much in too short a time. On the other hand, some of these countries just lagged behind, though progressing relatively faster than in the past. That also created disparate changes in their “aggregate demand and aggregate supply” situations. As we know, the exchange rate of a country’s currency depends on the supply of and the demand for the currency of that particular country, the demand for foreign currency went up in some countries as they demanded more foreign goods, propped up by the new-found oil wealth. This was particularly so because, even though they turned fabulously rich almost overnight, their economic base, harking back to tribal system of poor trading, was too backward. On the other hand, new discoveries of means of transportation and new demand for oil-driven industrialization led countries after countries, especially in the west, to go hungrier and hungrier for more and more oil, foreign demand for ME oil was on the increase. As a result, the demand for the currencies of these oil-rich nations also gyrated upward for continuing purchase of oil. That is to say, supply of currency also went up. However, as some countries could supply more oil and some less, demand for an individual country’s currency was also tagged to the availability of oil supply. So the supply of currency varied from one country to another. On the other hand, the thrust of modernization affected all of these countries almost equally. Yet, the countries with relatively more domestic endowment of oil could extract more aggregate demand than the countries with relatively less endowment of oil. So the demand for foreign currency varied from one country to the other. These demand-supply variations in currencies across these countries in the Middle East cause variations in the exchange rates.

Three, there is difference within Arab cohesiveness. They are, at least outwardly, bound by apparent religious coherence. Yet they are basically islands unto themselves. Religion is just a façade of self-aggrandisement. Deep inside they are ruthless economic players no less than what we could see in the nineteenth-century robber barons (Rockefeller, Carnegie, Stanford, and the like) of the U.S. To adduce an example, they were supporting OPEC, in a sort of “unholy alliance” in a paradigm of oligopoly, for fleecing other nations with their new-found oil wealth, setting ever-increasing oil prices within a cartel setup. Yet, at heart, they harboured the seed of “cheating,” which is not admissible in oligopoly (one oligopolist dares not raise price or lower price unilaterally). History tells us the swing producer Saudi Arabia, in a bid to make a killing, dared to cheat other members, to sell more oil and boost up the coffer. That triggered the price war –oil price plummeted, and American reverted to gas-guzzling huge Fords and Chryslers. This speaks of the lack of any inherent oneness in economic pursuit and financial transactions.

Naturally enough, there is not much change in their otherwise fissiparous tendencies that are historically borne out. These Middle East countries –such as Oman, Saudi Arabia, and Qatar –started with different valuations of their currencies, owing to factors as explained above, when they emerged into important economic players in a globalized setting of the modern world economy.

Four, the demand for foreign currency also varies both inter-spatially and inter-temporally. That varies from country to country because not all countries are equally wealth. On the other hand, their demand is mellowing down to rational proportions. At first, the nouveaux riche, wallowing in unprecedented wealth, became crazy in both spending abroad and spending in foreign commodities, quite irrationally, in a desire to show off in “ostentatious consumption on a gigantic scale,” which may be likened to the psychological state of mind of a poor boy dreaming of inadmissible good things of life and suddenly becoming too much rich to fall into an orgy of expenditures. So, e. g., a sheik or his sister may rent the whole floor of an expensive hotel, using a couple of rooms and leaving 50 or 60 vacant rooms. This “waste proclivity” is another reason for high demands for foreign currency, hence the implication of exchange rates. Yet they are becoming more and more educated, more and more rational, more and more financial savvy. As such, the demand for foreign currency is also changing. Another reason is that they are trying to utilize their own resources more, thereby reducing dependence on foreign companies. For example, they somehow in the past managed to get the full share of Aramco from only 20%.

SUMMARY
No wonder, owing to the factors playing in the arena of Middle East financial markets, you can see Qatari Riyal = Rs 14.9 and Saudi Riyal = Rs 14.48, quite close, yet Omani Riyal = Rs 140, far too high. In fact, take it that fluctuations are the norm, not exceptions.
Dear Prashant, I hope I have been able to walk you through this rather tortuous path of financial practicum. This is a vast field. You may focus your periscope farther and farther, and you are like to see the horizon expanding further and further. I will be happy if my explanation helps to put you on the right pedestal.




---------- FOLLOW-UP ----------

QUESTION: Dear Prof Eklimur Raza

Thank you.

Would you like to add one more factor mentioned from my side below
for the currency rate fluctuations ?

Factor : Trade, Diplomatic, International Foreign Relations between India and Qatar, India and Oman, India and Saudi Arabia, India and Iran ?.

Could the above mentioned factor can influence the Riyal currency rate fluctuations between the mentioned Gulf countries and India ?

Awaiting your reply,

Thanks & Regards,
Prashant S Akerkar

Answer
Hi Prashant,

I am happy that you have been able to examine the factors responsible for fluctuations in ME foreign exchange rates so perceptively.

Yes, I would like to add to whatever set of factors I enumerated as responsible for currency-rate fluctuations in the Middle East, not one, but all the three factors you have put up for consideration. This is, however, with some requisite presuppositions.

THE CAUSAL EXPLANATIONS HAVE BEEN BASED ON “VARIABLES” IN AN ENDOGENOUS SETUP
To mince no words, the term “factor” has been applied both in your query and in my response as “cause” directly responsible for diverse fluctuations in the currency exchange rates of currencies in different Middle East countries. As such, our logical (syllogistic) model had the ideational construct that could be mathematically understood as a causal relationship construed as formulation in functional relationship. That is to say, we had a functional relationship for one particular ME country something of the sort:

Y=f(X1, X1, …Xn),

where X1, X2, etc., are the “independent variables” and Y is the “dependent variable.” For all the countries under consideration, there would therefore be so many Ys (number of equations) with more or less the same number of independent variables. Let’s stick to one representative country, and we may then generalize that to the number of countries under consideration.
As you already know, Y stands for fluctuation of currency exchange rate in one country. We found out why those take place; and we had the independent variables. This is just one vector in our analysis. If we take all the vectors –i.e., all the countries in question –we do end up with a matrix. The idea is the same.

Let’s recall that our independent variables boiled down to aggregate demand for, and aggregate supply of, the domestic currency. Aggregate demand and aggregate supply, we know and we even adumbrated in the analysis, refer to a variety of disparate types of commodities. It is the interaction of the demand for and supply of currency that ultimately determine the rate of exchange at which the domestic currency would be traded for foreign currency in the aggregate. We also mentioned that there is a temporal phenomenon –i.e., this intersection changes over time as demand and supply also change over time, or the exchange rate does fluctuate over time. Secondly, we were comfortable with the idea that different countries in the Middle East have divergent ideas about satisfaction of demand and meeting supply, thereby engendering inter-country exchange-rates fluctuations.

Given that, our formulation simply had an endogenous model, with dependent variable (exchange-rate) and independent variables (aggregate demand for commodities and aggregate supply of commodities in a ME country) interacting in a global market. These independent variable impact the dependent variable via embodiments in the forms of “demand for foreign exchange” and “supply of domestic currency.”  So ours is basically a model of DERIVED DEMAND AND DERIVED SUPPLY.

SHOULD TRADE, DOMESTIC/INTERNATIONAL FOREIGN RELATIONS BE CONSIDERED AS FACTOR?
A perceptive student like you know it well that in economic theory we have both “movements along the demand and supply curves” [which actually mean extension or contraction caused by independent VARIABLES, such as price in ordinary market-equilibrium model] and “shifts in demand and supply curves” [which actually refer to impingement of one or more of PARAMETERS or EXOGENOUS VARIABLE, such as fashion or income in ordinary market-equilibrium model]. Yet in a complete dynamic market model, such as the cobweb model which we may solve with simple difference or differential equations, “shifts” do exert themselves to go in tandem with “movements” with oscillations of different amplitudes, either divergent or convergent or “waltzing around.”

SOME DIGRESSION
[If you want to get yourself acquainted with these concepts at an advanced level, you may refer to W. J. Baumol’s excellent book “Economic Dynamics.” This gives a beautiful nonmathematical exposition to “Historical Dynamics” (I have made reference historical dynamics in my previous response to your query) and also gives mathematical explanations to these concepts (these, however, require university-level advanced calculus).]

“PARAMETERS MAY AS WELL EXPLAIN FACTORS BEHIND FLUCTUATIONS IN EXCHANGE RATES THROUGH EXTERNAL SHOCKS [CHANGES IN TRADE RELATIONS, DIPLOMATIC RELATIONS, ETC.]

Quite the same, we may assume that “other things remain constant” –there is no change in trade or diplomatic relations –when, as we have done in the previous analysis, only variables like aggregate demand and aggregate supply come into play.

When “other things” may not remain constant –i.e., when “external shocks” are infused into the system though changes in diplomatic or trade relations with other countries –there are shifts in the “functions,” and we have new equilibrium in a comparative-static setup.

Now the question is, do we take that in our notional model of explanation? Well, generally we may not. However, whenever a change in trade relation takes place, that change does affect exports and imports. Similar effects are may be produced by changes in diplomatic relations. The point, though, is that such changes take place only once in a while, and that therefore affect the fluctuations in exchange rates only indirectly, and only if such changes take place. On the other hand, even without such changes –assuming status quo –aggregate demand and aggregate supply as variables MUST exert the influence.

SUMMARY
Considering all these aforementioned relationships, in a broad sense I would be inclined to add international trade and diplomatic relations as adventitious factors to the prime factors responsible for fluctuations of foreign-exchange rates in the Middle East countries  

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Eklimur Raza

Expertise

It appears some students in this website are confused about elasticity of demand and the slope of the demand curve when they are trying to figure out why rectangular hyperbola comes up in case of unitary demand curve. First, they don't know that RH can be depicted in a positive quadrant of price,quantity plane. Secondly, they make the mistake that the slope of RH is constant at -1. Two points could help them: first, e=1 at each and every point of the RH, because the tangent at any point shows lower segment=upper segment (another geometric definition of e); yet slopes at different points,dQ/dP, are different; second, e is not slope but [(Slope)(P/Q)]in absolute terms. Caveat: only if we measure (log P) along the horizontal axis and (log Q) up the vertical axis, can we then say slope equals elasticity --in which case RH on P,Q plane is transformed into a straight-line demand curve [with slope= -tan 45 deg] on (log Q),(logP) plane, and e= -d(log Q)/d(log P). [By the way, logs are not used in college textbooks --although that is helpful in econometric estimation of elasticity viewed as an exponent of P, when demand equation is transformed into log-linear form.] I have not found the geometrical explanation I have given in any textbook followed in undergraduate and college classes in Canada (including the book followed in a university where I taught for a short time and in the book followed in George Brown College, Toronto, where I teach.

Experience

About 11 years' teaching economics and business studies, and also English, history and elementary French.Practical experience in a development bank, working with international donor agencies like the World Bank and the ADB. Experience in free-lance journalism, including Canada's "National Post."

Organizations
I teach micro- and macroeconomics at George Brown College (continuing education), Toronto, ON, Canada.

Publications
Many articles and editorials, on different subjects, in English newspapers. Recently an applied Major Research Paper, based on a synthesis of the Solow growth model and the Lewis two-sector model, has be accepted by Ryerson University, Toronto. Professors Thomas Barbiero and Eric Cam, Ryerson University, accepted the paper.

Education/Credentials
Master degree in Interantional Economics and Finance and diploma with honours in Business Administration from Canada.

Awards and Honors
Received First Prize in an inter-university Literary Contest.

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