Foreign Exchange
Foreign exchange rate, is simply the cost at which one currency can be changed into another. Exchange rates vary very frequently. National currencies are extremely important for modern economies to operate. They allow us to properly figure out the value of any good across borders of countries, oceans, and cultures.
A brief History of Exchange Rates:
For centuries the currencies around the world were backed by gold. Initially as set by the United States, the value of one ounce of gold was $35, and after the second world war, countries began to value their currencies on the basis of the Dollar (USD). Since the value of gold is easily related to the value of the US dollar, as mentioned above, all countries, on the basis of their value of gold could set a value in respect to the US dollar too. For example, if the Gold in your country costs four times more than in the United States, then the US dollar would be four times your currency.
This method of valuing currencies, however, was replaced by the real study of economics. The US dollar still dominates but there have been a lot of fluctuations too, later on the cost of an ounce of gold, in US dollars rose from $35 to $70 which meant that the US dollar was directly cut by half.
In 1971, the gold standard was altogether removed, which meant that the currency no longer represented a value to a precious item. The market forces alone determined its value.
Exchange rates are often expressed in US dollars and the Euro accounts for almost 50% of all currency exchange transactions in the world.
Methods Of Exchange:
There are two main systems used to determine a currencies exchange rate, that are –
Floating Exchange Rate, and
Pegged Currency.
A currency is technically worth whatever buyers are willing to pay for it. This is determined by Supply and demand.
Floating Exchange Rate –
A floating exchange rate is a system in which the price of the currency of a country is decided by the foreign exchange market based on the supply and demand in comparison to other currencies.
Advantages of using floating exchange rates –
Reduces the need of intervention by the central bank
There is little need for capital flow restrictions
Protects a country from imbalances and problems in the economies of other countries
Reduced need of international management authorities of exchange rates
Disadvantages of using floating exchange rates –
Floating exchange rates are highly volatile
There exists a problem in allocation of resources in this method
There is less fiscal discipline in this method
Pegged Currency Rate –
Pegged Currency rate or Fixed Currency rate is a method of exchange in which the currency of a country is pegged with the currency of another country or any other measurable value such as gold.
Advantages of Pegged Currency rates –
It can create a stable economy, especially for the smaller country and help with planning
It has a credible and fiscally disciplined monetary policy
It reduces the volatility of the currency
Disadvantages of pegged currency rates –
It increases the influence of a foreign country on the monetary policies and other domestic affairs of the country
Pegged currency rates tend to stay in disequilibrium
Increased risks of deviation of the rate of the currency from it’s fundamental value
Factors affecting Foreign Exchange Rates:
Inflation Rates – Changes in the inflation in the market, or the prices of goods can cause changes in currency rates. A country with lesser inflation will examine appreciation in its value and a country with higher rates of inflation will see a depreciation its value.
Interest Rates – Interest rates, foreign exchange rates and inflation rates are all related to one another. When there are higher interest rates it may result for the better for foreign exchange rates as when the interest rates are high, lenders receive larger sums of money, thereby more foreign investment can be attracted and help in san increase in foreign rates.
Balance of payments – A country’s current account shows balance of trade of foreign investment. It holds the total number of transactions that are the exports, imports, debt, etc. A deficit in current account due to spending more money on importing products rather than earning through sale of exports causes depreciation. Balance of payments changes exchange rate of its currency.
Political Stability – A countries political environment can affect its currency rates. A country with a stable political environment and less likely to face any political issues in the future with clear monetary policies is more likely to attract foreign investors and foreign capital. The increase in foreign capital in a country can help increase the rates of a domestic currency.
Impacts of Foreign Exchange on People:
A strong currency makes imports cheaper. This in turn reduces inflation and might also lower the cost of living in a country. A countries currency directly influences all things bought and sold inside it. Most people witness foreign exchange when they travel and have to get their currency changed for another. Other things like Groceries, Fuel, Jobs, Investments and loans are all affecting by the strength of a currency therefore its exchange rate. All of these are examples that many people have to deal with on a day to day basis and often see fluctuations in their prices. For example the prices of groceries will be less if there is less inflation and it will be more of the inflation rates are higher. Fuel prices also fluctuate often and all this is directly or indirectly affected by the strength and rates of a currency.
Common Laws and Regulations of the Foreign Exchange Market:
The foreign exchange industry is a very large and lucrative industry, it is one which observes currencies getting exchanged every minute of the day. Given the involvement of currencies from across the globe, governments attempt to implement rules and regulations to all foreign currency trading platforms.
A few active regulatory bodies that govern the foreign exchange market:
1.The FCA (Financial Conduct Authority)
2.The CTFC(Commodity Futures Trading Commission)
3. The NFA(National Futures Association)
Common laws that prevail in the market:
• Each foreign exchange broker or platform must have a license to function in the country you live in. If they do not, you could be trading illegally.
• Each licensed foreign exchange dealer or broker has to accept regular reviews and audits of its operations to ensure it strictly maintains the national regulations and industry standards.
• The law states that foreign exchange brokers must stick to their contracts with each trading client. Failure to comply can lead to their license being revoked.
• A key feature of forex regulation is that each forex broker must have enough funds to cover their clients’ investments.
• All forex brokers and platforms must comply with fair representation legislation, clearly disclosing all potential risks involved with forex trading. Any forex broker that promises you will make a profit should be left well alone.
How COVID-19 is Effecting the Foreign Exchange Market:
The impact on world currencies:
Since the start of the COVID-19 outbreak the markets have been highly volatile. With a nationwide lockdown in most countries, If the talk about India, we can observe that with a nationwide lockdown in place and all activities and movements being restricted a lot of businesses have been effected. When businesses and offices are shut there is very little movement of money inside the country. In times like this a lot of foreign Investments are pulled out and new investments and Foreign Capital cannot be introduced. If COVID-19 was an issue only in India, India would have seen major losses in the long run but because this is an issue around the globe to comparative depreciation is little. It is times like these when inflation rates begin to soar in the market, a higher inflation rate also indirectly means more expensive imports, therefore imports will be more expensive than what we earn by exports and hence the current account of the country will run in a deficit.
Affects of COVID-19 across the globe:
In India:
Recently after the Coronavirus outbreak the Rupee hit an all time low against the United States Dollar at a value of Rupees 76.5 against 1United States Dollar. Foreign Investors are continuously withdrawing their money from India due to uncertainties caused by the pandemic. India’s Foreign Exchange Reserves fell by a very large amount, to the tune of 11.98 Billion United States Dollars to 469.09 Billion United States Dollars The gold reserve that had been rising for a while now, too saw a downfall of 1.61 billion United States Dollars According to the data shared by the Reserve Bank of India
The European Crisis:
With number of deaths in Italy now passing China, and other countries like Spain, Germany and France also facing a lot of strain on the health services and financial reserves in facing the pandemic that is COVID-19, the EUR/USD is on a fairly downward fall since the beginning of the year 2020.
Even though the European Central Bank (ECB) has announced they would put in funds to the tune of €750 billion into the economy to help manage the financial downfall from the pandemic of coronavirus on 12th March.
In the UK, the implementation of safety measures against coronavirus were slow in coming, which caused a lot of hinderance and problems in the functioning of the entire country, coupled with the Bank of England reducing the interest rates down to 0.1%, their current account deficit and continuing Brexit uncertainties, investors are selling off sterling, driving the value down as a result. Hence making their economy and currency weaker.
However, the one positive point to consider from this is that other countries within the European Union are learning from previous mistakes made by countries most affected by the coronavirus in the early stages of the outbreak, introducing much stricter coping strategies and laws right away rather than waiting. It’s thought that this aware and active approach could help with the recovery of the euro in the long-run, leaving them in a position to make a quicker economic recovery and get back to normal.
The United States Crisis
Across the United States, despite their initial reluctance and not being ready to take early measures in the prevention of spreading of COVID-19, investors are still readily and happily buying US dollars. Some of this has to do with the Federal Reserve’s willingness to provide as much liquidity to the market as possible and their availability of funds, as well as the dollar historically being seen as one of the strongest currencies and known as the ‘currency of last resort’, which is currently helping to retain and hold the dollar’s value to investors. Most investors believe that even with a downfall the dollar will be as strong as it ever was.
However, over the coming weeks and months, the realities of the coronavirus outbreak in the Unites States will inevitably and irrefutably put a strain on their medical and economic stability and their slow reactions to the virus hitting the United States could mean they are also slow to recover. As with most countries hardest hit by the pandemic, economists are predicting that a recession in the United States is almost a given – which could hamper the recovery for the entire global economy.