Exchange Rate

Exchange Rate
How did the Rupee Perform in 2022?

• During the year, the rupee fell to a lifetime low of 83.2 against the
dollar. Compared to rupee, depreciation of other Asian currencies
was to a lesser extent.
During the year, the Chinese Yuan, Philippine Peso and Indonesian Rupiah fell
around 9%. South Korean Won and Malaysian Ringgit declined by nearly 7% and
6%, respectively.
Understanding Exchange rate
• If we assume the UK and France both produce goods that the other
wants, they will wish to trade with each other. However, French
producers require payment in Euros and the British producers require
payments in pounds Sterling. Both need payment in their
own local currency so that they can pay their own production costs in
their local currency. The foreign exchange market enables both French
and British producers to exchange currencies so that trades can take
place.
• The market will create an equilibrium exchange rate for each
currency, which will exist where demand and supply of currencies
equates.
Types.
Demand for Foreign Exchange
Fluctuations in Exchange Rate
1.Inflation Rates
• Changes in market inflation cause changes in currency exchange rates.
A country with a lower inflation rate than another's will see an
appreciation in the value of its currency.
• The prices of goods and services increase at a slower rate where the
inflation is low.
• A country with a consistently lower inflation rate exhibits a rising
currency value while a country with higher inflation typically sees
depreciation in its currency and is usually accompanied by higher
interest rates.
2. Interest Rates
• Changes in interest rate affect currency value and dollar exchange
rate. Forex rates, interest rates, and inflation are all correlated.
Increases in interest rates cause a country's currency to appreciate
because higher interest rates provide higher rates to lenders, thereby
attracting more foreign capital, which causes a rise in exchange rates.
3. Country's Current Account/Balance of Payments
• A country's current account reflects balance of trade and earnings on

foreign investment.
• It consists of total number of transactions including its exports,
imports, debt, etc.
• A deficit in current account due to spending more of its currency on
importing products than it is earning through sale of exports causes
depreciation.
• Balance of payments fluctuates exchange rate of its domestic
currency.
4. Government Debt
• Government debt is public debt or national debt owned by the central
government.
• A country with government debt is less likely to acquire foreign
capital, leading to inflation.
• Foreign investors will sell their bonds in the open market if the market
predicts government debt within a certain country. As a result, a
decrease in the value of its exchange rate will follow.
5. Terms of Trade
• A country's terms of trade improves if its exports prices rise at a
greater rate than its imports prices. This results in higher revenue,
which causes a higher demand for the country's currency and an
increase in its currency's value. This results in an appreciation of
exchange rate.
6. Political Stability & Performance
• A country's political state and economic performance can affect its
currency strength.
• A country with less risk for political turmoil is more attractive to
foreign investors, as a result, drawing investment away from other
countries with more political and economic stability.
Recession
• When a country experiences a recession, its interest rates are likely to
fall, decreasing its chances to acquire foreign capital.
• As a result, its currency weakens in comparison to that of other
countries, therefore lowering the exchange rate.
Speculation
• If a country's currency value is expected to rise, investors will demand
more of that currency in order to make a profit in the near future. As
a result, the value of the currency will rise due to the increase in
demand.
• With this increase in currency value comes a rise in the exchange rate
as well.
Change in Demand for Foreign currency
Change in Supply of Foreign Currency
Questions
• Suppose countries in Europe ran a budget deficit, increasing real
interest rates in Europe.
• As a result, people in Mexico would want to buy financial assets in
Europe and would need euros in order to do so.
• As a result, the demand for the euro increases and the euro
appreciates, as shown in the graph below:
Solution
Why does an increase in the real interest rate
shift the supply curve?
• If the interest rate increases, it becomes more beneficial for people to
save their money in banks instead of investing it into firms.
• This decrease of investment reduces the goods that suppliers are able
to supply, which is a leftwards shift of the supply curve.
Leftward shift of supply curve
Interest Rate Differentials:
• Higher Interest Rates: When a country's central bank raises its interest
rates, it often attracts foreign capital seeking higher returns on
investments. This increased demand for the country's currency can lead
to an appreciation of its exchange rate.
• Lower Interest Rates: Conversely, lower interest rates may result in
decreased demand for a currency as investors seek higher returns
elsewhere. This can lead to depreciation of the currency.
• When Interest rate Increases
• when interest rates rise, investors are attracted to a currency and invest
in it more heavily. As more investors are attracted, demand for the
currency increases, and its value goes up.
Interest Rate and Exchange Rate
• When Interest rate Increases
• Investors are attracted to a currency and invest in it more heavily.
• demand for the currency increases, and its value goes up.
• How does economic productivity affect exchange rates? Does higher
productivity lead to a stronger currency?
Economic productivity affects the exchange
rate
• Increase in the productivity of tradable goods in a country
• increasing demand for that country's product.
• It also increases the exports of goods.
• It results in more demand for domestic currency and less demand for
foreign currency for purchasing domestic goods.

Exchange Rate

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Exchange Rate

How did the Rupee Perform in 2022?

• A country's current account reflects balance of trade and earnings on

• Investors are attracted to a currency and invest in it more heavily.

• increasing demand for that country's product.

• It also increases the exports of goods.

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