Key factors affecting Exchange Rate
Every country has its own currency that has its own individual value. Whether you are an active trader in the foreign exchange market, planning your vacation abroad or shopping an exotic product online, understanding of exchange rate is essential. The value of currency across the world differs as the Kuwaiti dinar varies from the US dollar.
The fact that a country‘s financial healthiness is judged by its exchange rate, makes evident its significance. Other than factors like interest rate and inflation, exchange rate is deemed to play a pivotal role in the country’s trade activities with it being one of the most valued factors.
Exchange Rate: Understanding the Term
Based on the value of a currency vis-à-vis others, a country’s purchasing potential is decided, followed by an understanding of the variance between the demand and supply. In simple words, the exchange rate is the rate at which one country’s currency may convert into another.
A country with a stronger currency will lose as its exports will be more expensive and imports will be cheaper in the foreign market. On the contrary, a country with a weaker currency will benefit from as imports will be expensive and exports cheaper.
The FX market ascertains this rate based on varied crucial factors including interest rates, inflation, rate of trade, etc.
Factors Influencing Rate of Exchange:
While a number of factors influence of this rate, the primary ones include:
Balance of Payment: It is the total number of transactions including its exports, imports, debt, etc. that a country deals with, in comparison to other countries determining the amount it has to pay or receive. A country that is in a position to receive more than pay will have a higher value for its currency and vice versa.
Government policies and measures: A country prone to political turmoil and continuous clashes will deter the investor’s confidence lowering the value of the currency. However, a country with sound financial and trade policies without giving room for uncertainties will witness a positive influence on the value of a currency directly and indirectly, as it will influence every aspect of trade including tariffs, exports and imports, etc.
Sentiment: The way, market perceives our economy as an investment destination, is essential. If it confides in our policies and believes that we are on the right track, paving way for an unprecedented growth, it will express its interest by investing with the expectation of receiving lucrative returns. Hence, sentiment of the market tends to be a major determinant of a country’s exchange rate.
Inflation: A country with lower inflation will have an upper-hand in the market and have a higher currency value. On the other hand, countries with high inflation will consequently witness depreciation in their currency in comparison to the currencies of their global counterparts.
Interest Rates: When interest rate for a particular currency rises, it will have a consequent effect on the yields for the assets denominated in that particular currency, nudging way for an increase in demand by investors and hence, increase the value of currency. Investors generally try to seek a balance between yield returns and safety of funds.
Significance of these factors:
Conversion of currencies is possible because of the existence of the exchange rate theory, enabling people to trade, and transfer funds between two countries. It also represents a country’s performance and its stance globally as an investment destination. Strong Exchange rate directly mirrors a country’s backdrop: balanced payments, less debts, increased number of trades and a good demand for its currency, which as a result encourages more investment from the FIIs, and strengthen its standing globally. This will hence instigate growth, development, and global competitiveness of a country, representing a cycle.
Exchange Rate affects everybody:
Not only the global investors or the traders in the stock market, exchange rate influences everybody. Whether you are travelling abroad for a financial trip or vacationing with your family, exchange rate matters. It is necessary to understand exchange rate when buying the revered exported watch, online. A greater understanding of this term will enable you to save more as you will know when to go in for your desires.
So, what to encode?
By comprehending the market rightly and trading at a ripe time, you will be benefited. Next time before going ahead on your foreign trips, you will be in a better position to decide the time, book cheaper flights, get better deals, and leverage your savings.
Businesses can also observe a huge impact on their balance sheet by taking the right decision with respect to imports and exports and also about foreign currency borrowings. An informed decision would enable competitive pricing which will help gain market share for exports and better pricing with respect to imports.
Understanding the exchange rate mechanism is, hence, necessary, helping you to make more informed decision.
About The Author:
This article has been written by Kotak Securities which is a leading share broking firn providing services such as demat accounts, mutual funds, IPO services. To know more about Kotak securities, you may visit http://www.kotaksecurities.com