Factors Influencing the Exchange Rates

Published On November 7, 2020 | By William Thomas | Business

Before checking at these factors, people must sketch out the way the exchange rate movement affects a nation’s trading relationships with other nations. Then, a higher valued currency makes a country’s import less expensive, and its exports more expensive in foreign markets. A lower-valued currency makes imports of a country much costly and its exports cheaper in foreign markets. They can expect a higher exchange rate to worsen a country’s balance of trade, while a lower exchange rate improves it.

Public Debt

Countries are willing to interact in large-scale deficit financing to pay for public sector projects and governmental funding. Even though such activity stimulates the domestic economy, nations with massive public deficits and debts are less attractive to foreign investors. And this is because a large debt boosts inflation, and if inflation is high, the debt will be serviced and basically paid off with lower real dollars in the future.

For the worst-case scenarios, a government might print money to pay part of a huge debt. Nevertheless, increasing the money supply inevitably causes inflation. And if a government failed to service its deficit through domestic means – selling domestic bonds, adding money supply -,, then it needs to increase the supply of securities for sale to foreigners. Thus, it will lower their prices.

Above all, a massive debt may prove worrisome to foreigners if they think the country risks defaulting on its obligations. Foreigners will be less eager to have securities denominated in that currency if the risk of default is high. Therefore, the country’s debt rating is a crucial determinant of its exchange rate.

Terms of Trade

The ration weighing prices to import prices, the terms of trade are associated with the current account and the balance of payments. When the amount of a country’s exports grows by a higher rate compared to its imports, its terms of trade have favorably developed—increasing terms of trade exhibit a higher demand for the country’s exports. In return, it results in mounting revenues from exports, which gives increased demand for the country’s currency – and a rise in the currency’s value. And if the price of exports surges at a lower rate than that of its imports, the currency’s value will diminish concerning its trading partners.

Strong Economic Performance

Moreover, foreign investors inevitably look for stable countries with strong economic performance in which to invest their capital. And a country with positive attributes will lure investment funds away from other countries perceived to have more political and economic risk. For instance, political turmoil can cause a loss of confidence in a currency and a movement of capital to the currencies of way more stable countries.


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