Key Takeaways
- The Indian rupee fell 12 paise to close at 94.93 against the US dollar, its second straight day of depreciation. It is a useful live example of how exchange rates move.
- Purchasing power parity links exchange rates to price levels and works as a long-run anchor. It is a poor guide to a single day's move.
- Interest rate parity and capital flows often explain short-run currency moves better. CFA candidates need to know which parity condition fits which time horizon.
The rupee slips again
The Indian rupee depreciated for the second consecutive day against the US dollar, falling 12 paise to close at 94.93 in Mumbai. A paise is one hundredth of a rupee, so the move is small, roughly an eighth of one percent. It now takes almost 95 rupees to buy one US dollar, and the pattern of two weaker closes in a row is the kind of drift that makes people ask whether the dollar is simply getting stronger or whether something deeper is going on.
This is where a CFA candidate should slow down. A quoted exchange rate is a price, and like any price it can be pulled by several forces at once. Some forces act over days, such as capital moving between countries. Others act over years, such as differences in inflation. The parity conditions in the economics curriculum are a set of tools for separating these forces. One headline number can illustrate several of them, and the exam expects you to know which one applies to which question.
What purchasing power parity says
Purchasing power parity, or PPP, starts from a simple idea. If the same basket of goods costs more in one country than in another, the exchange rate should eventually adjust so that the basket costs the same in both places. The starting point is the law of one price: identical goods should sell for the same price once converted into a common currency, because otherwise buyers and traders would shift purchases to the cheaper market.
There are two versions worth knowing. Absolute PPP is about the level of the exchange rate, matching price levels across countries. Relative PPP is about changes. It says a currency should lose value over time when its home inflation runs higher than inflation abroad, and gain value when inflation is lower. Relative PPP is the version most often used in practice, because it does not require the two countries' baskets to be identical.
Apply that logic to the rupee. If prices in India were rising faster than prices in the United States over a long stretch, relative PPP would predict a gradually weaker rupee against the dollar. The news item, however, does not give inflation data, and we should not pretend it does. All it shows is the exchange rate move itself.
Why PPP is a weak tool for a two-day move
The key limitation is time. Price levels change slowly, and goods markets adjust slowly. Many items are not traded across borders at all, such as haircuts, rent and local services. Trade barriers, transport costs and taxes also keep prices apart. Because of this, exchange rates can sit far from their PPP-implied value for years, and research has generally found that PPP tends to hold better over long horizons than short ones.
So a 12 paise fall over one session says almost nothing about PPP. Inflation did not change meaningfully in a day. Something faster must be at work, which is exactly why the curriculum teaches PPP alongside other conditions rather than as a stand-alone answer. Treat PPP as a gravitational pull toward a long-run level, not as a forecast for tomorrow's close.
The other parity conditions and the stronger dollar
Short-run currency moves are usually tied to money and expectations rather than shop prices. Interest rate parity connects exchange rates to interest rate differentials. The international Fisher effect then joins the story by linking nominal interest rate gaps to expected inflation gaps, which brings us back to PPP.
Some parity conditions are dependable, while others are only tendencies. Real exchange rates also move because investors shift money across borders, because risk appetite changes, and because central banks act differently. A rupee close of 94.93 is the net result of all of these pulls, and the headline cannot tell you which one dominated on a given day.
Over years, ask about relative inflation and PPP. Over weeks and months, ask about interest rates, expectations and capital flows. Over a single session, remember that markets can move for reasons that no parity condition fully captures.
What to take from this, and how to test yourself
Watch whether the rupee's weakness continues or reverses in the coming sessions, and treat each move as a prompt to reason through the parity framework rather than as a verdict. Ask what the move implies for import costs, for returns on foreign-currency assets, and for investors who hold assets in another currency. The same exchange rate move can help an exporter and hurt an importer, and the CFA exam likes to test that kind of two-sided thinking.
To check that you can separate the parity conditions under exam pressure, try a free 30 question mini mock from EduFite. If the currency questions feel shaky, the full EduFite course walks through each parity condition with structured practice so that the logic is automatic on exam day.
FAQ
What is purchasing power parity in simple terms?
Purchasing power parity says exchange rates should adjust over time so that a similar basket of goods costs the same in different countries once converted into one currency. It is based on the law of one price.
Does purchasing power parity explain daily currency moves?
Not well. Price levels change slowly, so PPP is a long-run anchor. Daily moves are more often tied to interest rate differences, capital flows and shifts in investor expectations.
What is the difference between absolute and relative PPP?
Absolute PPP concerns the level of the exchange rate and equal price levels across countries. Relative PPP concerns changes, suggesting that a currency with higher inflation should depreciate against one with lower inflation.
How does a stronger dollar relate to the parity conditions?
A stronger dollar can be examined through PPP over long horizons and through interest rate parity and capital flows over shorter horizons. The horizon decides which condition is most useful.