Foreign exchange rate is defined as “the rate at which one country’s currency may be converted into another”. Money exchange rates are determined by several factors including, interest rates, current account on balance of payments, economic growth and inflation.
If you are an expat sending money home; an aspiring Forex trader; a finance enthusiast who is enamoured by world economics, then you must know the reason(s) why foreign exchange rates fluctuate.
In this context, the rate that is charged for using or saving money of a particular country is called an interest rate. Charged when money is borrowed, paid when money is saved, interest rates of a country attribute to the value of foreign exchange rate of its currency.
For e.g. If India’s interest rates rise compared to other countries for investments, it will attract more foreign investments, thereby earning more savings in Indian banks. This will increase the demand for the Indian Rupee, causing a rupee appreciation.
Higher interest rates will cause currency value appreciation and the vice versa.
Inflation rate is the rate at which the prices of goods and services rise in a country. Countries that have a low inflation rate, have an appreciated currency value, thereby increased purchasing power. Higher inflation rate will hamper purchasing power.
For e.g. If a soda in the USA costs $1 in a given year, and the inflation rate is 10%, the same soda will cost $1.10 the next year.
Balance of Payments
Balance of Payments or Current Accounts reflect the payments paid and received between a country and its trading partners for imports, exports and debts. A deficit in the current account means, there’s more of importing and spending (buying foreign currency), than exporting and receiving (earning foreign currency). This excess demand for foreign exchange will lower the country’s exchange rate.
Countries usually borrow to pay for large public sector projects. While such an activity stimulates the domestic economy, nations with high deficit are less likely to attract foreign investors. This leads to inflation which will result in a dip in the value of exchange rates.
Economic Performance and Political Stability
A country with a stable political and economic performance attracts foreign investments. An increase in foreign investments will result in the appreciation of the currency value. Political and economic disturbances in a country will repel foreign investors thereby causing fluctuating exchange rates.
The relationship between exchange rate and the above mentioned factors (and many more) are subtle and intriguing. While it sounds complex, it is actually simple if one regularly follows up on world affairs and global economy. But if you are just a humble expat, wanting to send money at the right time to save on exchange rate differences, then the above information is a starter, and there are many money transfer and Forex agents who will assist on the same.