FACTORS AFFECTING FLEXIBLE EXCHANGE RATE:

Shifts in the demand and supply schedules for foreign currency take place on accountof a number of factors. Some of them are enumerated below.

If economic growth in India increases relative to the US, then Indian demand for USgoods increases (imports rise). It shifts the supply schedule of Indian rupees to the rightthereby depreciating rupee as against the dollar.

Second, if the inflation rate in India rises faster than that in the US, imports becomecheaper.  It leads to more imports resulting in supply schedule of rupees shifting to theright thereby depreciating the rupee against the dollar.

Third, if interest rate in India increases relative to that in the US, capital inflows rise.With an increase in demand for investment in demand, the demand schedule (for rupees)shifts to the right resulting in rupee appreciating against the dollar.

Fourth, expectations also affect the exchange rate.  Speculations about interest rates,growth rates, etc. influence the supply and demand forces, which in turn, influence theexchange rate.