Key Economic Factors That Influence Foreign Exchange
Author(s): Nishant VivekBeing one of the most important determinants of a country’s relative economic health, aside from factors such as interest rates and inflation, foreign currency exchange rates are the most watched, analysed...
Being one of the most important
determinants of a country’s relative economic health, aside from factors such as
interest rates and inflation, foreign currency exchange rates are the most
watched, analysed and manipulated economic measures. They impact the real
return of a foreign investment and the balance of trade of a country- such is
its importance. Exchange rates are simply the value of one currency in
comparison to another.
A higher-valued currency makes a
country's imports less expensive and its exports more expensive in
foreign markets. A lower-valued currency makes a country's imports more
expensive and its exports less expensive in foreign markets. A higher foreign currency exchange rate can be
expected to worsen a country's balance of trade, while a lower exchange rate
can be expected to improve it.
Exchange rates are determined by factors, such as
interest rates, confidence, the current account on balance of payments,
economic growth and relative inflation rates. For example:
●
If the US business became relatively more competitive,
there would be greater demand for American goods; this increase in demand for
the US goods would cause an appreciation or an increase in the value of
dollar.
● However, if
markets were worried about the future of the US economy, they would tend to
sell dollars, leading to a fall in the value of the dollar.
Some of the
leading factors that influence the forex exchange rates are:
1. Inflation Rates
Changes in market inflation cause changes in currency exchange rates. A
country with a lower inflation rate will see an appreciation in the value of
its currency. A country with a consistently lower inflation rate exhibits a
rising currency value while a country with higher inflation typically sees
depreciation in its currency and is usually accompanied by higher interest
rates.
2. Interest Rates
Changes in interest rate affects currency value and dollar exchange
rate. Increases in interest rates cause a country's currency to appreciate
because higher interest rates provide higher rates to lenders, thereby
attracting more foreign capital, which causes a rise in exchange rates.
3. Country’s Balance of Payments
A country’s current account reflects balance of trade and earnings on
foreign investment. It consists of total number of transactions including its
exports, imports, debt, etc. A deficit in current account due to spending more
of its currency on importing products than it is earning through sale of
exports causes depreciation. Balance of payments fluctuates exchange rate of
its domestic currency.
4. Government Debt
Government debt is public debt or national debt owned by the central
government. A country with government debt is less likely to acquire foreign
capital, leading to inflation. Foreign investors will sell their bonds in the
open market if the market predicts government debt within a certain country. As
a result, a decrease in the value of its exchange rate will follow.
5. Terms of Trade
Related to current accounts and balance of payments, the “terms of
trade” is the ratio of export prices to import prices. A country's “terms of
trade” improves if the price of its exports increases at a greater rate than
that of the imports. This results in higher revenue, which causes a higher
demand for the country's currency and an increase in its currency's value. This
results in an appreciation of exchange rate.
6.
Political
Stability & Performance
A country's political state and economic
performance can affect its currency strength. A country with less risk for
political turmoil is more attractive to foreign investors, as a result, drawing
investment away from other countries with more political and economic
stability.
7.
Recession
When a country experiences a recession,
its interest rates are likely to fall, decreasing its chances to acquire
foreign capital. As a result, its currency weakens in comparison to that of
other countries, therefore lowering the exchange rate.
When speaking of foreign currency
exchange, there are a number of service providers for the same, all over the
globe. Unimoni (formerly known as UAE Exchange India) is one such service
provider. With their
customer centric approach, they have been one of the premier names in Money Transfer, Foreign Currency
Exchange, Payment and Credit solutions.
Therefore, we can say these 7 factors
forms and affects the forex exchange rates of a country, whether high or
low.