The exchange rate is one of the most important factors in international trade. It is the ratio at which one currency can be exchanged for another. Exchange rates fluctuate due to a variety of factors, including economic and political conditions, supply and demand for currencies, and even fish farming systems. This article explores the various influences on exchange rates and how they are determined. It will also discuss how these impacts can affect firms that engage in international trade.
How is the exchange rate determined?
The reasons for the rise and fall in the currency rate are due to the expected strength of the country’s economy. Where the exchange rate in industrialized countries is determined based on the concept of supply and demand, As the increase in supply leads to a decrease in the value of the exchange rate and demand leads to an increase in the value of the currency over the exchange rate, Therefore, central banks monitor the amount of liquidity offered from the local currency and increase the supply of local currency or withdraw from banks according to the need to determine a high or low exchange rate.Some countries also set a fixed exchange rate that is determined in advance by the central bank and changes it as needed through the central bank’s view of the currency value.
There are many factors that determine the exchange rate. And all of them are related to the commercial relationship between two countries. to remember, Exchange rates are relative and expressed in the form of a comparison between the currencies of two countries. The following are some of the initial determinants of currency exchange rates between two countries. Note that these factors are not arranged in any particular order. As with many economic principles, The relative importance of these factors needs much debate.
exchange rate
In the international financial markets, the currency of any country is treated like a commodity that can be bought and sold against any other currency, and the exchange rate between one currency and another is called the exchange rate.
That is, the exchange rate is the quantity or amount of a particular currency that must be paid in order to obtain one unit of another currency
influences on the exchange rate
1- Interest rates and inflation
Inflation is the rate at which the cost of goods and services increases over time. Interest rates refer to the amount banks charge for borrowing money. These two are related to the fact that people tend to borrow and spend more when interest rates are low, Which leads to increased costs. These rates are direct indicators of a country’s current and future economic performance and can influence the decisions of forex investors and traders around the world. An increase in the interest rate is usually followed by a rise in the value of the domestic currency. This usually happens because the economy is growing too fast and central banks are trying to slow down inflation
2- Current account deficit
The current account is the trade balance between a country and its trading partners. It describes the difference in value between goods and services traded with other countries. If a country buys more than it sells, The trade balance represents a deficit. It directly affects the exchange rate because the country will need more foreign capital, Thus reducing the demand for the local currency. This oversupply of the local currency leads to its depreciation against foreign currencies.
3- Government debt
This is the total national or public debt owed by the central government. A country with a large amount of government debt is less likely to attract foreign investment and foreign capital acquisition, Which leads to inflation. It may also happen that existing foreign investors sell their bonds in the open market if they expect an increase in government debt. This will increase the supply of domestic currency, thus reducing its value.
4- Terms of trade
Terms of trade are the ratio of a country’s export prices to its import prices. When a country’s export prices rise at a rate greater than its import prices, Terms of trade are improving. This, in turn, leads to increased revenues, increased demand for the country’s currency, and an increase in the value of the currency. This cumulatively causes the currency exchange rate to rise.
5- Economic performance
One of the many factors affecting a country’s economic performance is its political stability. A country that enjoys a stable political environment, It attracts more foreign investment and vice versa. An increase in foreign capital leads to a rise in the value of its domestic currency. This stability also directly affects the financial and trade policy, Thus eliminating any uncertainty in the value of its currency.
6-stagnation
during a recession, Interest rates in any country are likely to fall, Which reduces their chances of obtaining foreign capital. This, in turn, weakens the currency of the country concerned and weakens the exchange rate.
during a recession, Interest rates in any country are likely to fall, Which reduces their chances of obtaining foreign capital. This, in turn, weakens the currency of the country concerned and weakens the exchange rate.
7- Speculation
Investors demand more of a country’s currency when it is expected to appreciate in value to make a profit in the near future. as a result , The value of the currency increases due to the increase in demand for it. Which in turn causes the exchange rate to rise as well. With so many factors involved, Exchange rates are subject to fluctuations and this can be very distressing for people who transfer money abroad frequently. Although watching currency corridor rates can give you a good idea of the best time to make transfers, It is best to stay updated with the exchange rates in real time.