Exchange rates play a very significant role in building an
economy. It is a vital indicator of a country’s economic growth. A foreign
exchange rate is not just a matter of fact for the government and financial
institutions but also has an impact on the investor’s portfolio. Why does the
exchange rate keep fluctuating? Have you ever thought about it? Well, this
article is all about knowing the factors affecting the foreign exchange
rate. Keep reading for more information.
What are the factors affecting exchange rates?
Several factors decide the exchange rates, and it is good to
know some of the top forces affecting a country’s trading business with other
countries. This explains about the foreign exchange rate
today.
1 Indian Rupee = 0.014 US Dollar as per 27th Jan 2020
Changes in Inflation rates – The inflation rate is a
rate where the price of goods and services increases over a while. A country
with a lower rate of inflation will see an appreciation in the value of its
currency, whereas a country with a high inflation rate experiences currency depreciation
leading to high-interest rates as well.
Changes in interest rates – interest rates and
inflation are correlated to foreign exchange rates. Any increase in the
country’s interest rate causes the currency to increase its value, thereby
resulting in growth in the foreign exchange rates.
Current account – an existing account is the balance
of trade between a country and its trading partners. A current account reflects
all payments done between countries for goods and services, interests, and dividends
traded. A deficit in the current account means that the country is spending
more on foreign trade that its earnings. This also means that the country is
borrowing capital from international sources to meet the deficit.
Recession – in case the country is under recession,
leading to a fall in interest rates, the chances of borrowing foreign capital
will be high. This results in a weaker currency and lower foreign exchange rate.
Government/ public debt – the national debt owed by
the central government is what we call as public or government debt. Countries
having high public debts are less attractive to foreign investors — a low
public debt rate results in the increased value of the currency and exchange
rate.
Economic stability and performance – a country’s
economic growth have a lot to do with foreign investment and exchange. A
country with strong economic growth attracts foreign investors, resulting in
appreciation in the country’s currency.
Export-import price ratio – if the export prices go
high than the import prices, the demand for the country’s currency will go
high. This results in increased currency value and appreciation in the exchange
rate.
Final word: To conclude, a declining exchange rate
decreases the purchasing power of income and vice-versa. All these factors, as
mentioned above, help in evaluating the exchange rate of a country. Apart from
these, several other minor factors are related to interest rates and inflation
of a nation. Investors should be aware of the currency values and exchange rates
so that they get good returns on their investments.
