The foreign exchange market is one of the most blooming markets of the present world. In terms of size, forex market is one of the largest, based on volume, liquidity and regular turnover. Foreign exchange rate, or the forex rate, is the means through which a country’s economic heath and stability can be determined and this is the sole reason why this rate is kept under a constant watch.
The exchange rate is the rate at which a country’s currency can be may be converted to another. It has a high fluctuating pattern and fluctuates based on demand and supply of the respective currencies. For transferring or investing money overseas, one needs to understand the basic factors which tend to affect the forex rate.
A few important factors affecting the foreign exchange rate are discussed below:
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[*]Inflation rates:  A country’s inflation rate greatly affects the currency exchange rates. A country with a lower inflation rate will see an appreciation in the value of its currency. The prices of goods and services of this country will increase at a slow rate. On the other hand, the country with a high inflation rate will undergo depreciation in the value of currency. Although the interest rates are higher in the latter case.
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[*]Interest Rates: Fluctuations in interest rate, affect both forex and inflation rates as all the three rates are correlated. When a country’s interest rates increase, its currency rate appreciates as higher rates give a higher rate to lenders, which in turn attracts more foreign capital, resulting in a rise in the exchange rates.
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[*]Current account of the country: A country’s current account is an image of its balance of trade and earnings on foreign investment. A deficit in the country’s account may arise when more of the country’s currency is spent on acquiring imported products, rather than gaining from selling off exported items. This causes depreciation and in turn the exchange rate of the domestic country is affected.
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[*]Government Debt: A country’s central government is under government debt when it carries a burden of public or national debt. If a country faces such debt, its capability to attain foreign capital reduces great fold. If foreign investors predict such debt within a country, they are likely to sell the bonds in the open market, thus increasing supply, resulting in a decrease in the exchange rate.
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[*]Terms of Trade: The ratio of the export prices to the import prices is referred to as the terms of trade. A greater hike in the export prices compared to the import prices; result in improvement of the terms of trade. This ensures higher revenue which in turn increases the value of the country’s currency due to increased demand for the currency. This leads to an appreciation of exchange rate.
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