Key Economic Factors That Influence Foreign Exchange

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.