What Happens When Exchange Rate Increases.Rate of Exchange is the rate at which the currency of one country is converted to the currency of another country. It is the value of one currency in terms of another. In other words, it is the value of foreign currency to be paid in local currency. The determination of value or price of currency depends on the equilibrium of its demand and supply.
What Happens When Exchange Rate Increases.
The point or price at which the demand and supply of foreign currency become equal, that price is considered exchange rate. If the demand of any country’s currency is more then exchange rate will be in its favour and vice versa. For example, when we purchase one U.S. Dollar for Rs. 80/- the rate of exchange between the Dollar and Pak-rupee shall be $ 1 = Rs. 80.00. In other words, the ratio between the Dollar and Pak-rupee shall be 1:80.
- The foreign exchange rate or exchange rate is a rate at which the
one currency is exchangedfor another.
- The exchange rate as the price of one unit of foreign currency in terms of domestic currency.
Main Points of Definition
- The value or price.
- For exchanging or converting.
One country currency into the currency of another country.
I Spot Rate:
Ilmeans the rate of the moment prevailed in market. For example, il, mu |-o lo currency dealer and ask him about exchange rate, the rate told i , • hi h i icy dealer is called spot rate.
forward rate is related to future transactions or deliveries. In fact, I * I i.liesprovide hedge to an importer against loss due to devaluation i Iimiiii- currency. It means if an importer takes forward rate from bank In. i.• inn of devaluation then the bank will provide the foreign currency ..ill. dr<ided (Forward) rate irrespective of the current exchange rate.
» Selling I Buying Rate:
Selling rate is a rate at which the currency dealers sell the foreign y and Buying rate is a rate at which one is willing to buy foreign • hiiincy.
I Inter Bank Rate:
I he rate at which the central and commercial banks sell and buy i..1. ipn currency to each other is called inter bank rate.
I he rate, which is officially issued by central bank to exchange i..।. ipn i urrcncy is called official rate.
CAUSES OF CHANGES IN THE EXCHANGE RATE ]
I lie factors, which cause changes in exchange rate, are discussed Un under.
I ( hanges in Prices:
Il is changes in the relative price levels that cause changes in the • •<<himgc rate. Suppose the price level in Britain rises relative to the US pm r level. This will lead to the rise in the price of British goods in terms nl pound. British goods will become dearer in the US. On the other hand, lli< American goods become cheaper in Britain and their imports into llniain increase. So the demand for dollars will increase. So the exchange i uh- is established at higher level from the point of view of the US. It implies appreciation of ‘he value of the dollar and depreciation of the \ line of (he pound.
1 Change in Exports and Imports:
The demand and supply of foreign exchange is also influenced by • Ii.mges in exports and imports. If exports of the country are more than
imports, the demand for its currency increases, so that the rate of exchange moves in its favour. Conversely, if imports are more than exports, the demand for the foreign currency increases and the rate of exchange will move against the country.
- Capital Movements:
- Short-term or long-term capital movements also influence the exchange rate. Capital-flows tend to appreciate the value of the currency of the capital-importing country and depreciate the value of the currency of the capital-exporting country. The exchange rate will move in favour of the capital-importing country and against the capital-exporting country.
- Influence of Banks:
Banks also affect the exchange rate through their operations. If the commercial banks issue a large number of drafts and letters of credit on foreign banks, the demand for foreign currency rises. The bank rate also influences the exchange rate. If the bank rate rises relative to other countries, more funds will flow into the country from abroad to earn high interest rate. It will tend to raise the demand of the domestic currency and the exchange rate will move in favour of the country.
- Influence of Speculation:
The growth of speculative activities also influences the exchange rate. If the speculators expect a fall in the value of currency in the near future, they will sell that currency and start buying the other currency as they expect to appreciate in value. Consequently, the supply of the former currency will increase and its exchange rate will fall. While the demand for the other currency will rise and its exchange rate will go up.
- Stock Exchange Influence:
If the stock exchanges help in the sale of securities, debentures, shares etc. to foreigners, the demand for the domestic currency will rise on the part of the foreigners and the exchange rate also tends to rise. The opposite will be the case if the foreigners purchase securities, debentures, shares, etc. through the domestic stock exchanges.
- Structural Influences:
Structural changes are those changes, which bring changes in the consumer demand for commodities. They include technological change, innovations, etc. Such structural changes tend to increase the foreign demand for domestic product. It implies increase in exports, greater demand for domestic currency, appreciation of its value and rise in the exchange rate.
- Political Conditions:
If there is political stability and the government is strong and efficient, foreigners will have tendency to invest their funds into the country. With the inflow of capital, the demand for domestic currency will rise and the exchange rate will move in favour of the country. On the contrary, if the government is weak, inefficient and dishonest, and there is no safety to life and property, capital will flow out of the country and the exchange rate will move against the country.