“Macros” affecting the exchange rate and their counterparts
A country’s economic health is determined by the number of foreign exchange reserves it holds. The macroeconomic elements like inflation, interest rates, current account deficit which is the gap between the imports and exports of a country have a lot to do with the change in the dynamics of the national economy. An exchange rate in the simplest sense can be referred to as the price of Indian rupees in terms of foreign currency (presently 1 United States dollar= 69.55 Indian rupees). So, if a person is hoping to pay a debt as well as claim credit in foreign currency, he or she will be very speculative of the exchange rates. Let us go through some of the macroeconomic determinants that affect the exchange rates and their counterparts.
- Inflation- The price fluctuation in the domestic, as well as the global economic market, impacts the decision of the central bank as well as the exchange rates. Example if a country’s currency is depreciating than the central bank will look to curb it by increasing the interest rates or vice versa. This will help in currency stabilization in terms of rupee depreciation (it means to fall in the value of the home currency in terms of foreign currency).
- Interest rates - Interest rates are very crucial when it comes to determining at what rate currency is being exchanged. For an economic policy to flourish, it is equally important to keep in view the aspects of the monetary policy (a policy that is laid to control the money supply in the economy). For example - when there is a fall in the rupee, the central bank will go for a contractionary policy where the interest rates are increased so as to keep in check the imports.
- Economic growth- Financial globalization has brought all the countries into one single domain of interaction and transaction. For a country to have enough of the forex reserves it is important to have stability in the home currency so as to facilitate investment. The strength of a currency determines the impact it will be having on the foreign exchange market (a market where currencies like dollars are being traded)
- International trade and Forex-Balance of trade which is the difference between the value of a country’s imports and exports for a given period of time is another determinant for the exchange rate. Here the depreciation (fall in the value of a currency and appreciation (rise in the value of a currency) comes into play. A depreciation in the currency can negatively affect the exchange rate when it comes to importing from other countries. So, going by the typical formula, a country whose goods are globally on high demand would like to see its currency appreciating as it will help in terms of exports.
- Price of oil- Crude oil being the world’s most precious commodities is the most important determinant when it comes to the exchange rate. Its price affects the entire global economic system in one way or the other. Crude oil prices are very sensitive and are subject to change accordingly. Example in 2017 the crude price hit a new low at $60/barrel. This price hurts the ones whose currency rate is depreciating. Fall in the value of the currency, in turn, would accelerate the import price. Thus, the price of oil is directly proportional to demand and supply in the international market which can also affect the rate of exchange along with the commodities traded in the foreign exchange market.
Thus, the macro dynamics are very much influencing in nature for the global financial market to respond. It can rightly give an overview of how the macroeconomic elements can determine the economic volatility of an economy.