BE-Exchange Rate Movements and Its Impact on the Economy

8/3/2019 BE-Exchange Rate Movements and Its Impact on the Economy

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Exchange rate movements and its

impact on the economyAn Exchange Rate is the rate at which one nation's currency can be exchanged for that of

another. Exchange rates impact, and are impacted by, international trade, in a free-market

system that helps to maintain a balance of trade and balance of capital.

Exchange rates, like any other commodity, are based on supply and demand for particular

forms of currency.

Supply Domestic currency supply changes as a result of a country's fiscal and monetary

policies.

Demand Demand for currency can be influenced by a large number of factors, includinginterest rates, inflation, and views on impending government regulation.

How appreciated or depreciated the exchange rate is relative to its long-run fundamental

purchasing- power-parity level depends on (a) the magnitude of the expected differential in

interest rates between the home and foreign countries, and (b) the expected duration of the

interest rate differential.

The shorter the expected duration, the less will be the deviation of the current exchange rate

from its purchasing-power-parity value; the longer the expected duration of the differential,

the greater will be the deviation.

The larger the differential in interest rates at any one point in time, the larger the difference

between the initial exchange rate and its ppp value; the smaller the differential, the smaller

the appreciation or depreciation of the exchange rate.

The exchange rate movements and exchange rate regimes assume very high priority in the

management of macro-economic policies in the economy.

The exchange rate movements has direct impact on the export competitiveness, cost of

imported raw material and consumer products, cost of serving foreign borrowings, services

sectors such as tourism, BPO, foreign direct investments, the general inflation, the pricestability, general employment and income of the economy.

The business community is more concerned about the volatility of exchange rates, as high

volatile exchange rates would erode business competitiveness and the long-term business

relations with both buyers and the sellers overseas.

Fractional or slight changes in the movement of exchange rates will have profound and

occasionally even disproportionate impact on the economy at large. The monetary policy

formulators therefore naturally focus heavily on maintaining stability in the domestic foreign

exchange market.


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However, approved foreign exchange dealers in the private sector also play an important role

particularly for foreign exchange transactions pertaining to non-trade domain.

Increasing foreign exchange inflows from the services sector, workers remittances and

financial flows from the international sovereign bond issues and gradual increase of export

revenue are some of the other reasons attributed to the appreciation of the Rupee.

The RBI intervenes regularly in the market to mitigate excessive volatility in the exchange

rate and to ensure competitiveness of exports would not be eroded due to undue appreciation

of the their currency.

While market forces are largely reflected in the value of the exchange rates, monetary policy

also intervenes to avoid excessive volatility of the exchange rate. In this process, one of the

soft instruments being practised by the RBI is daily publishing of the Approximate Indicator

Exchange Rate based on the previous days market weighted average rates for the US Dollar.

Although this is the average rate for the US Dollar, the different commercial banks quotedifferent buying and selling rates with variant degrees of margins between the buying and

selling rates.

Understandably, as a general rule no commercial bank buys foreign exchange higher than the

buying rates quoted or sells below the daily selling rate indicated by the RBI.

However, some commercial banks depending on the quantum of the turnover of foreign

exchange dealing carried out by the bank and the amount tendered or purchased makes

certain exceptions to this rule.

The approved exchange dealers prepare to offer higher rates of buying than the RBI

indicative rates depending on the quantum of foreign exchange tenders, denomination of the

currencies and the bargaining power of the customers. High valued foreign currencies always

maintain high margin of difference between the selling and buying price.

The variation of the margin though not very high yet reflected noteworthy differences when it

comes to the question of large-scale international trade transactions. According to

representations made by the entrepreneurs engaged in international trade, transactions, this

variation with a high margin than the margin stipulated by the RBI erode their

competitiveness in the international market and the cost of imported raw materials, inputs and

consumer products.

Importance of Exchange Rates

Exchange Rates are very important for any country as they determine the level of imports and

exports. If a domestic currency appreciates with respect to a foreign currency, imported

goods will be cheaper in the domestic market and local companies would find that their

foreign competitor's goods become more attractive to customers. If the country has a strong

currency then its goods become more expensive in the international market, which results in

lost competitiveness. This is the reason that China, despite much pressure from the United

States, is not letting its Yuan appreciate.
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Importance of Exchange Rates for Investors

Exchange rate movements can have a significant impact on a company's returns.

Multinational companies may see significant shifts in their profitability, as foreign exchange

("FX" "forex") rates may make locally held currency more valuable. Even local companies

can be affected, as changing FX rates may substantially alter their material costs, or affect

their ability to sell their goods in foreign countries at competitive prices
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BE-Exchange Rate Movements and Its Impact on the Economy