The economic health of a country can be measured through GDP, but factors affecting GDP are interest rates, inflation and currency exchange rates. This rate plays a vital role in making better trade relations with other countries.
However, the exchange rate makes a great impact on investors' portfolios. The currency market is similar to stocks where trading can be made and it has the largest potential value than daily trading. This market provides the highest level of liquidity than stocks. The trading of exchange rate currency of different countries helps to give information about the economic condition of the country. The currency market involves buying and selling of different currencies.
Currency trading also involves the participation of banks, investment firms, hedge funds, forex brokers, etc. The Forex market is recognised as the most liquid market in the world. This market has large volumes of trading that cause price movement.
Benefits of trading in the currency market
Liquidity
Liquidity refers to the ease of finding sellers and buyers for assets within the market. The currency market offers high liquidity thereby increasing chances of success at the trade. It has been observed that the higher the transactions of currency the chances of liquidity and profit also increase in the forex market. Therefore, an immense amount of currencies are traded without affecting much price.
Leverage
Leverage is the opportunity to increase the business and generate more money from the lower investment. Therefore, the use of adequate leverage results in higher profit.
Accessibility
The foreign exchange market is highly accessible and can be daily traded across the world in currencies. Therefore, traders from across the world can trade in the market easily. Due to its accessibility, trade can be operated by big or small traders.
Arbitrage Opportunities
The currency market offers arbitrage opportunities for traders to make money. The arbitrage advantage relates to minor differences of currencies on various exchanges and thus creating a profit opportunity.
Hedging
The exchange rate has prime importance and helps the importers and exporters to save against unfavourable forex movements. Therefore, hedging helps in the safeguarding of exchange rates. Therefore, hedging has a vital impact on international trade.
Various factors that affect the exchange rates between two countries are listed below.
Differentials in Inflation
When the exchange rate of any country goes up, the exports become more expensive and imports become cheaper. The gap between a developed country and a developing country is due to the presence of exchange rates and inflation. Exchange rates are affecting price stability and growth. Therefore, the country with higher inflation experiences lower currency rates for their trading partners.
Different in Interest rates
Interest rates, exchange rates and inflation jointly correlated for affecting International Trade. The trading condittions that has a higher interest rate will attract more foreign capital and the exchange rate also increases. Therefore, a lower interest rate will decrease the exchange rates.
Public Debt
The countries engage in deficit financing to pay for public sector projects. Therefore, nations with large public debts are less attractive to foreign investors. Therefore, large debt increases inflation and the debt will be paid off cheaper real dollars in the future. Therefore, the exchange rate has great implications for international trade.
Growth of Domestic Money
The other factors that affect exchange rates are the growth of the domestic money supply and will also affect the exchange rates in the market. If the economy is prospering, then foreign investors will be attracted to such an economy. The exchange rate also depends on the country's political imbalances that will also affect the loss of confidence in currency and movement of capital and its stability.
Economic Growth
The economic growth of the country is a vital factor for fluctuations in forex rates. A country with higher economic growth can be considered a strong economy and the exchange rate also increases. If the country is dependent on a single factor, it will increase the deficit of the country and will lose its value in the international market and trade. Therefore economic growth can be measured through the gross national product.
Size of the balance of Payments
Balance of payments also plays a vital role in international trade. If the balance of payments of any country is more, then the currency of such country is depreciated in the international market.
Bank Intervention
The exchange rate is also affected by the policies adopted by the central bank of the country for regulating international trade. If the bank changes the policies as per the needs of the situation, the trade becomes easy and efficient.
However, exchange rates are of two types fixed exchange rates and floating exchange rates. The fixed exchange rates will have different impacts o trade and flexible exchange rates have separate impacts on trades. The fixed exchange rates will make the trade less risky. Due to a fixed exchange rate, speculation cannot be possible. The government cannot change the foreign trade policy due to the presence of fixed exchange rates. This may affect adversely making payments at the time of crises. These may also result in the depletion of foreign exchange reserves.
However, a fluctuating exchange rate can be helpful at the time of external adverse factors. Due to fluctuating exchange rates, the government can freely change the policies as appropriate for the economy. It also helps in the correction of the balance of payments. However, it may also create instability in the economy and trade.
Supply and demands are vital factors for exchange rates. When the rate of currency increases, it results in more currencies being bought and vice-versa. There are several other factors like economic events, political changes or fundamental factors. However, every business is affected by the exchange rate fluctuations directly or indirectly. However, if a country's exchange rate decreases, imports become expensive and exports become cheaper in foreign markets.
The role of the exchange rate is impactful in economic diversification. Foreign exchange rates are denoted as the value of one currency compared to another. While trading in the international market, exchange rates are considered to be a vital factor. Excessive demand for forex lowers the national exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic profits.
There is a close relationship between exports and exchange rates within a country. By comparing the exchange rate of various countries, the cost of living can be compared easily. Therefore, foreign exchange rates interventions and capital account regulations can be used for maintaining competitive exchange rates. This will help in promoting growth and stability.
So, we can conclude that exchange rates have a powerful impact on international trade. The exchange rates are affected by various factors like inflation, interest rates, economic growth and central bank intervention. The increase in exchange rates can become imports dearer and exports cheaper in the market. The exchange rate helps the country to identify its trade policy and helps in taking economic measures and movements. Therefore, the exchange rate has an impact on investors' portfolios.
The ratio of export prices to import prices and the terms of trade is related to the current account and balance of payments. If the country's export price rises above the import price, the terms of trade have improved steadily. This, in turn, leads to higher export revenues and higher demand for national currencies. If the rate of increase in export prices is less than the import price, the value of the currency to the trading partner will decrease.
