Do you know what are the factors that affect exchange rates? AAMcourses got you covered.

Im sure you guys have heard that the exchange rate is increasing or decreasing. That means that our nation’s currency value against other countries is fluctuating. Now, the question arises is why does this fluctuation happen? What are the factors that affect exchange rates? How is it decided?

Many factors affect exchange rates, such as the country’s inflation, trade flow, interest rates, etc. As for how the exchange rates are determined, there are four theories to determine the exchange rates. The four theories are Traditional theory, PPP, IRP, and IFE.

READ ABOUT : 4 Exclusive Exchange Rate Theories of International Finance

In this article, we will discuss what are the factors that affect exchange rates of a country.

Factors That Affect Exchange Rates

Inflation 

Inflation refers to the price level of the market. A higher inflation rate indicates that the currency of the value is decreasing. A higher inflation rate of a country also indicates that it has a low purchasing power. In the same way, a lower inflation rate will aid in increasing the currency value and powering power.

Interest Rate

Inflation and interest rate are two of the most focused field factors that affect exchange rates. The inflation rate and interest rate are closely related and interdependent on each other. The central bank manages both the factors, interest rate, and inflation. According to the requirements, the central bank increases or decreases the interest rate, which ultimately also impacts the inflation rate.

Current Account 

A country’s current account refers to its imports and exports. If the import is more, it creates a current account deficit. More imports can result in currency depreciation. In the same way, more export will create a surplus current account which will result in currency appreciation.

Public Debt 

Another one of the factors that affect exchange rates is the public debt. Public debt refers to the capital procured by the country from the world market, i.e., other countries, for domestic development. When a country borrows from the world market, it reduces the foreign reserves or puts the country’s current account into deficiency.

Political Stability 

One of the major factors that affect exchange rates is the country’s political stability. When the country’s political factors are updated accordingly, the government changes according to rules, policies, etc. are the factors that affect exchange rates. A stable political environment will attract more foreign investments as it reflects low risk.

Economic Condition 

A country’s economic condition is also one of the factors that affect exchange rates. If a country is underdeveloped, developing, or developed stage, it affects the decision of foreign investors. Investors prefer a developing country as their investment avenue as it shows growth. Very few or none prefer a developed country for investing, nor do they need it.

The country’s economic situation also affects the investor’s decision. A country with a booming market is likely to attract more investors than a country in its recession.

Trade Policies 

A country’s trade policy can heavily influence imports and exports. A country with lower trade barriers can increase its imports. In contrast, a government with more trade barriers will decrease imports. And trade flow due to policies will ultimately be reflected in the current account of the country.

ALSO READ : 8 Importance of Balance Of Payment You should be aware of 

FAQs

Closing Statement 

The above-mentioned are the factors that affect exchange rates of a country. These factors influence the fluctuation of exchange rates. Understanding the exchange rates and their factors can not only be a sign for a woke country member but also an important factor for business. These factors help to forecast the future market conditions and help the business be prepared for it.

I hope this article about the 7 factors that affect exchange rates is informative. If you have any doubts or suggestions, deposit your thought in the comment box.