Major Factors Affecting Foreign Exchange Rates

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Daffa Zaky writes: Foreign exchange is a global market where trading of currencies is done all round the clock. The rate at which these currencies are exchanged (Forex rate) is very important. This is because it is used to determine economic status or growth of a particular country in comparison to other countries. The foreign exchange rate is usually monitored and constantly evaluated because it’s a key determining factor for a country’s economic stability. People who send and receive money from abroad have to constantly monitor the exchange rate so as to know the appropriate time to do so.

Foreign exchange rate can be defined as the value of a country’s currency in relation to another country’s currency. It therefore has the domestic currency aspect and the foreign currency aspect. This rate is never constant but varies from time to time depending on the changes in the global market. These changes in the market are usually brought about by the equilibrium between demand and supply of currencies between countries. It is therefore very important that one understands the determining factors that affect exchange rates when sending and receiving money from outside the country.
In this excerpt we analyze some of the critical factors that play a major role in determining the rising and falling of the exchange rate of a particular country. We also explain why this rate keeps on varying so as to help you understand the suitable time to receive or send money overseas. 

• The rates of inflation in the market

The variation in the inflation rates in the market is one of the critical factors that affect the exchange rate of a country. Technically, a country which has a sustainable low inflation rate will have a stronger value of the currency compared to countries with higher inflation rates with all the other factors being held constant. In countries where the inflation rate is low, the market value of goods and services usually appreciate at a relatively slow rate compared to countries with higher inflation rates. When the low inflation rates are sustained for a longer period of time then the value of the currency appreciates steadily. On the other hand, countries that have high inflation rates for a long period of time usually have high interest rates on goods and services offered and at the same time experience constant depreciation in the value of their currency.

• The rates at which interest is charged

Interest rates, foreign exchange rates and the rates of inflation are always related and play a big role in determining the stability of the market environment. Any slight changes in interest rates will definitely affect the value of the currency and its exchange rate in the foreign market. An increase in the interest rate will cause the value of the currency to appreciate. This is because borrowers are charged higher interests and in return it attracts more foreign capital. Therefore higher interest rates will cause the exchange rates to go up. 

• A country’s current Savings and investments or Balance of Payments (BOP)

How a country has managed to balance between trade and the earnings got from foreign investments is very critical in determining the exchange rate. This information can be found in the current account which contains the sum total of all transactions done by the government including imports and exports. In the event that the government spends more on imports as compared to the earnings that it gets from exports, it creates a deficit in its current account. This kind of deficit causes depreciation in the value of domestic currency causing instability in the balance of payments. In such a situation the exchange rate of the domestic currency becomes highly volatile and unpredictable.

• The amount of debt accrued by the government

Any unpaid dues by the central government are always considered to be public or civic debt and a liability. The bigger the debt the less likely the government is able to negotiate and get foreign capital. The result of this is increased inflation in the country. Most investor will opt to trade their bonds when the debts are too high. This will always lead to a fall in the value of the current exchange rate.

• Ratio of export to import prices

The ratio of export prices to import prices in a country is usually referred to as terms of trade. This ratio also affects the balance of payments (BOP) and current accounts. The terms of trade are good if the export prices are higher than the import prices or rise at a faster rate than the import price. The effect of this is higher revenue for the country. The domestic currency therefore will have a higher demand and the local currency increases in value. All this culminate to an increase in the value of the exchange rate.

• Political status of the country

Politics will always affect the economic performance of a country. A country that experiences political and civil unrest is considered risky for foreign investors. This means that any foreign investment will have to be diverted to countries that are stable politically. Sound trade agreements between countries attract more foreign investments leading to increased foreign capital. A country marred with constant civil unrest and political instability attracts a lot of uncertainty in the Forex market leading to depreciation of the exchange rate for its currency.

• Economic recession

A significant reduction in economic activity of a country will lead to a decline in interest rates. This will minimize the chances of the country to get foreign capital. This will subsequently lead to weakening of the domestic currency in relation to foreign countries and therefore decreasing the value of the exchange rate.

• Speculation

This is more of a wait and see approach of foreign exchange. If the traders see that in the near future a certain currency will increase in value, they will buy that currency at the prevailing lower rate now. Then they will stay with it until when the value increases so that they sell it at more value than when they bought it. This eventually will increase the exchange rate. 
In conclusion, all the above factors affect foreign exchange rates. This information is particularly important for people who often send and receive money as it will help them determine the best time to do so. It is also important to know how to cushion yourself against such fluctuations. One can opt to have a locked in exchange rate which will ensure that they get the agreed rate despite any factors changing which may lead to a lower rate. The disadvantage is that sometimes the exchange rates may be higher than the agreed rates hence one misses the opportunity to make that extra coin.

About The Author
Name : Daffa Z.
With over 7 years’ experience in the heart of the investment industry, Daffa Zaky has become one of the most respected commentators in the financial world. Daffa remains a keen forex and binary options trader and is a regular featured analyst for a number of online news portals and was responsible for FxDailyReport.com

Copyright © 2015 Daffa Zaky - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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