Trade across international borders for both exporting and importing is basic necessity for a foreign exchange. One can settle this transaction against products or services or complete the transaction by converting the currency into another. Ideally a trade constitutes a foreign exchange transaction but currency can be traded without any underlying which makes it a risky proposition.
The rate at which the currency is converted to another is determined by market forces and amongst that demand and supply for the currency is the key. Higher volume indicates the sentiment of traders in the current scenario. If the fluctuation in the foreign exchange market rate is not high then it provides great stability to the international traders as their cash flow is certain and forecasting becomes easier. Thus budgeting can be done from future growth perspective. All this helps in minimizing the production costs as planning can be done in advance, thereby making the product or services more competitive.
While doing an international trade, the currency risk is inherent to the markets. If one trades without realizing the effects of currency market risk, one is calling for trouble. Proper measures must be taken to mitigate the currency risks.
Effect of exchange rate on economy
If the domestic currency is strong, then imports become cheaper but that hampers exports, conversely a weaker domestic currency encourages more exports value but imports become expensive. Now import and export have direct affect on the trade surplus or deficit which in turn also affects the exchange rate. If exchange rates do not fluctuate, it creates stability in international trade. This helps the exporters to reduce their production costs and thus prove competitive in international markets while improving quality.
Any change in the exchange rate will have a direct effect on the prices of goods and services which are produced in the domestic country, relative to those produced overseas. An appreciation in domestic currency will make the local products and services expensive compared to those from other countries. While a falling domestic currency will give an edge to the goods and services as they become cheaper than overseas goods and services.
Foreign exchange impacts
For international trade, the impact of exchange rate is far reaching and do not come in limelight for occasional transactions like overseas remittances, travel for health or education, etc. Thus a stronger domestic currency may not always be good for the economy. If it has appreciated sharply, it can drag the economy and make it uncompetitive over the long term. From individual retail perspective a stronger currency may be a boon especially when converting to foreign currency, but a weaker currency may reap more economic benefits.
A country’s central bank uses the value of the domestic currency as an important tool while setting its monetary policies. It plays an important role in determining the rate of loans, how much is paid for regular groceries, or the returns one earns on the investment portfolio. Even the employment prospects are determined indirectly through the value of the domestic currency. Thus foreign exchange markets inspite of all the factors incorporate most of the sentiments expected and may still sometimes surprise the investors with the impact on the international trade.
08 May 2020 05:21 PM
Converting one exchange rate into another at a particular price makes transferring rates. Ideally all nations should be treated as equal and there shouldn’t be any exchange rate applicable which would mean to have a universal currency.
24 Apr 2020 03:08 PM
Managing risk in a financial market is required to keep a check on the adverse movements in the instrument of the market. Particularly in the foreign exchange market.
10 Apr 2020 06:12 PM
So was India’s decision on locking down the country for 21 days required? The implication on the economic growth or rather slowdown has only made many doubt the timing and preparedness of the decision.
24 Feb 2020 05:08 PM
When they say the currency markets are volatile, it is the spot exchange rate, which is being referred to, which fluctuates within seconds.
07 Feb 2020 03:19 PM
Derivatives market enables access to financial assets for trading at a future date and not just at the market trading date. In currency derivatives the trader agrees to buy or sell a fixed amount of a specified currency at the end.
27 Jan 2020 02:13 PM
Well devaluing a currency can give a thrust to the exports and reduce the trade deficit but for any economy which has higher imports, the consequences can be on the negative too.