The foreign exchange (forex) rate is an important parameter to determine the country’s economic situation. It helps to understand the country’s level of international trade and commerce. That is why it is essential to watch over the forex rates constantly. In this article, we will take a look at the primary factors which affect the forex rates.
Any country's currency can be converted into another’s. This is the simple meaning of the exchange rate. The demand-supply equation changes every day in the international money market. Accordingly, the exchange rate also fluctuates daily.
If a country’s currency is highly valued, then its imports will be cheaper and exports dearer. The opposite will happen if the currency is lower valued. A higher exchange rate means that a country’s balance of trade is in an unstable situation, while a lower exchange rate will improve the same.
A lot of people send or receive money to or from other countries every day. So, it is critical to know & understand the factors which influence foreign exchange rates.
Rate Of Interest
Any change in interest rate will have an effect on the foreign exchange rate. If the interest rate goes up, a country's currency will rise because lenders will get higher rates due to the increased interest rates. This will bring in more foreign capital, which pulls up the exchange rates.
Deficits In Current Account
A current account is a statement of the balance of trade between nations. If a country buys more & sells less, then there is a deficit in the balance of trade. The country will require more foreign capital, and this will pull down the demand for local currency. So, there will be an excess of local currency. And this excess will diminish its value against its foreign counterpart. The reverse will happen if the country buys less and sells more.
Level Of Inflation
A country with lower inflation rates will have a higher purchasing power, compared to a country with higher inflation rates. This will have a positive effect on its foreign exchange (Forex) rate. The opposite scenario will take place if a country is experiencing higher inflation and, consequently, lower purchasing power.
By government debt, we mean the total national debt that the central government of a country owes. If a nation’s government is highly in debt, then foreign investors will be unlikely to invest there. This will result in inflation. Also, foreign investors who are already present here might contemplate to sell off their bonds if they fear that government debts will rise soon. As a result, the local currency will be in excess supply. This will pull down the value of the local currency.
A country in deep political turmoil or instability will scare away foreign investors. Fall in foreign capital will lead to a fall in the value of the local currency. But a politically stable country, with strong economic policies, will attract foreign capital, as the business climate in this country will provide no scope of any turbulence. The rise in foreign capital will pull up the country’s foreign exchange rates.
Terms Of Trade
Terms of trade denote the ratio of a nation’s export prices to its import prices. If a country is exporting more than it is importing, it will have a favorable term of trade. This means that the country will have higher export revenues, which, in turn, will pull up the country’s currency value. The reverse will happen if the country imports more than it exports.
During times of recession, a country’s rates of interest fall. This diminishes its chances of acquiring more foreign capital. The currency situation becomes weak. Hence, the foreign exchange rate also suffers.
If investors make an estimation that a country's currency value will rise in the coming days, they will demand more of that currency, as they would want to make a profit. So, the currency value will go up as the demand has increased. This will have a favorable impact on the foreign exchange situation of the country.
To conclude, all these factors have an impact on the country’s foreign exchange situation. So, if you plan to remit or receive currency to or from abroad, keep yourself updated on these aspects so that you can have a positive outcome from the transaction.