An Exchange Rate Movements and Strategies in Foreign Exchange Market - Example

The success of an organization and the economy to a large extent is dependent on the manner in which the value of the currency is determined in relation to the currency of other country making exchange rate one of the important determinants for growth. Exchange rate impacts the growth of the economy as it helps to determine the purchasing power of money thereby impacting the purchasing power. The development of free trade movement which allows countries to trade commodities and other products between each other has increased the need and important of ensuring the correct exchange rate so that no country gains at the cost of others. The fluctuations in the value of exchange rate are due to different factors which impacts the overall growth in an influential manner. This paper analyzes the different factors which results in the fluctuation in the exchange rate. This is then facilitated by identifying the manner in which Reserve Bank of Australia when compared to other country looks to determine the manner in which the exchange rate will be determined. This will thereby help to understand the manner in which the impact of different options will be determined based on different factors. The overall analysis will thereby help to understand the manner in which exchange rate shapes the demand and supply thereby highlighting the manner in which the overall impact and growth of the economy will be determined. It is important to understand what exchange rate actually is. Exchange rate is the value of the domestic currency expressed against other foreign currency, the value of which is determined based on the demand and supply of currency. This brings to the notion that exchange rate has an impact on the trade relationship between economies and is an aspect which has to be carefully understood. Considering a situation where the value of a currency is higher compared to the currency of another country. This would mean that exports become expensive as the purchasing power of currency is low leading towards an increase in import. This creates a situation where economies have to face a situation of trade deficit. This thereby impacts the balance of trade and has an impact on the exchange rate as economies look towards external financing to fill the deficit. The exchange rate thereby gets affected and is finally determined based on the demand and supply of the currency. Thus, there are different factors which have an impact on the exchange rate of currency and some of the factors which have been identified to influence exchange rate is as Firstly, inflation of an economy influences and causes changes in exchange rate. An economy which has a low inflation rate witnesses an increase in the exchange rate primarily due to the fact that the purchasing power of the currency increases. Since, more and more products can be purchased from the same money it impacts the interest rate pushing it downwards. This makes borrowings easier and further helps to ensure a strong exchange rate (Basurt and Ghosh, 2000). But as interest rate falls the number of investors willing to lend money reduces which thereby again pushes the interest rate and results in inflation. The final price of the currency in relation to other currency is thereby determined by the forces of demand and supply and the strength of the forces determines whether the value of the currency will move up or down. The opposite happens in case the inflation rate is high. This thereby shows that inflation has an impact on the exchange rate between countries. Secondly, another important determinant which has an impact on the exchange rate between countries is interest rates. It is important to consider the fact that exchange rate, inflation and exchange rate are interrelated to one another and changes in any one has an impact on the other thereby leading towards a change in the final value of the currency (Basurt and Ghosh, 2000). When the interest rate which is controlled by Reserve Bank is altered and in our case it is increased it results in better return on investment. The opportunity to get a higher return on the invested money makes more and more people invest and this also at times results in increased foreign investment. This thereby pushes the interest rate and makes the value of the currency appreciate thereby making the purchasing power of money to increase. This has to be further studied by incorporating inflation as increase in inflation could result in a situation where despite high interest rate the exchange rate doesn’t moves high because of the fact that the increase in the purchasing power of money is compensated through an increase in inflation. Thus, the three factors needs to be considered together and cannot be treated in isolation so that the manner in which exchange rate changes can be studied with better accuracy. Thirdly, the other factor impacting exchange rate movement is current account deficit. Current account for an economy shows the different transactions that an economy has entered with another country and represents both the payment and receipts thereby highlighting the manner in which value between economies is determined. In case an economy has a current account deficit means that the economy has more spending than income. This has resulted in the final balance to be negative resulting in a current account balance to be negative (Keminsky and Schumulkler, 2003). To fill the gap the government looks to borrow money and since it is a current account deficit caused due to international transaction which involves currency of other country the same has to be financed to fill the gap. The government has to provide strong returns to be able to finance the required deficit resulting in higher returns which attracts people and investors. This brings a change in the exchange rate as it starts to fall resulting I a creation of a situation where the purchasing power of money falls. The opposite happens in case an excess thereby leading to a situation where the exchange rate is determined based in different changes in current account balance. Fourthly, changes in public debt also impact the value of currency thereby affecting the exchange rate. Considering a situation where the government looks to invest heavily in capital financing and looks to develop infrastructure. This will force the government to raise money from the public. To create a situation where people are willing to lend more and more money the government will be forced to sell securities at a lower price than they actually are in the market. The opportunity to make a higher return at lower risk will force the foreign investors to purchase the securities as the purchasing power of the current is low. This will be a situation where the actual exchange rate will be low and will slowly change based on the expected future demand and supply. While looking to raise money the credit rating of the securities, past performance and other indicators will be considered by the investor. Thus, the culmination of different factors will determine the manner in which the exchange rate will be determined and needs to be analyzed while looking to consider the fluctuations in the exchange rate. Fifthly, the manner in which economies enter into trade relations and the different terms which have been determined to find out the trade will have an impact on the exchange rate. An economy which has an increase percentage of export as compared to import will find an appreciation in the value of the currency. This would mean that more and more people will be demanding the currency which will create an impact on the demand for the currency pushing the entire value high. This will result in an increase in the value of the currency and increases the purchasing power of currency thereby having an impact on the exchange rate and pushing the entire rate to be high. The opposite happens in case of increased import thereby highlighting the manner in which exchange rate changes for an economy. Sixthly, another factor which determines the exchange rate is the political stability and economic growth that the economy is witnessing. An economy which is having a stable government and is experiencing high growth rate will find it easy to garner the required investments. This will result in an increase demand for currency thereby pushing the exchange rate to move upwards. This will thereby have an impact on the overall exchange rate between countries. The different factors as highlighted above has an impact on the exchange rate which has made the Reserve Bank of Australia look into those and based on it develop policies which will ensure a stable exchange rate and help the economy to grow (Debelle, 2012). The Reserve Bank of Australia has thereby looked to adopt the following policies to ensure stability in exchange rate. The Reserve Bank of Australia has ensured that the strategies are consisted with the government policies so that growth of the economy can be ascertained. This has thereby ensured no changes in the interest rate which has been kept at 2.75%. It has been possible to keep the interest rate intact because the economy has been able to keep a check on inflation which has allowed the strategies of growth to be properly implemented (Lowe, 2012). This has helped the different monetary and fiscal policies to provide the required return and has increased the avenues through which the overall efficiency and opportunity for growth has widened. Control in the inflationary condition has provided an opportunity to ensure stable exchange rate with little fluctuations. This has made it possible to ensure that the Australian Dollar trades at 0.90 times of Greenback. The overall impact has been control in the risk associated with currency fluctuations. This has helped to attract more and more foreign funds as visible from the increased foreign investment in Australian Stock Exchange (ASX) 200 (Debelle, 2013). This has been backed by loose monetary policies which have ensured the required flow of currency in the economy and has ensured that the demand and supply of currency balances thereby keeping inflationary conditions under control. The policies of the Reserve Bank of Australia has helped to ensure a foreign deposit of $36 billion out of which 45 percent is in US dollar, 45 percent is in EURO and the rest is help between Yen and Canadian Dollar (Vallence, 2012). This has ensured proper liquidity in every direction and has ensured proper management of different strategies in accordance with exchange rate. The government based on it has been able to take expansionary monetary and fiscal policies which have increased investment avenues and helped to develop a vicious circle through which money within the system is controlled and inflation is checked (Gould and Kamin, 2000). This has helped the policies with regard to exchange rate to be strong and based on the strong fundamentals which the market is providing has provided an opportunity through which the Reserve Bank of Australia has been able to ensure maximum growth for the economy. The paper thereby highlights the different factors which have an influence on exchange rate. It is to be considered that no factor in isolation has an impact on the exchange rate but it is the culmination of different factors based on the demand and supply which determines the exchange rate in the market. Looking to exercise and control inflation helps to ensure stability in exchange rate. The paper also shows the manner in which Reserve Bank of Australia has looked to implement strong monetary policies and ensure that the inflation remains under check. This has ensured a stable exchange rate and with strong fiscal policies and strategies adopted by the Australian government the opportunity of growth and having a stable exchange rate in the future increases. References Basurto, G. and Ghosh, A. (2000). The Interest Rate-Exchange Rate Nexus in Currency Crises. IMF Staff Papers, 47, Special Issue, 99-120 Debelle, G. (2013). The Reserve Bank’s Operation in Financial Market. Retrieved on August 5, 2013 from http://www.rba.gov.au/speeches/2013/sp-ag-260213.html Debelle, G. (2012). Regulatory Reforms and their Implications for Financial Markets, Funding Costs and Monetary Policy. Address to the Financial Services Institute of Australia, Adelaide, 18 September Keminsky, G. and Schumulkler, S. (2003). The Relationship Between Interest Rates and Exchange Rates in Six Asian Countries. World Bank, Development Economics and Office of the Chief Economist, Washington, D.C. Gould, D. M. and Kamin, S. B. (2000). The Impact of Monetary Policy on Exchange Rates During Financial Crisis. International Finance Discussion Paper 669, Board of Governers of the Federal Reserve System, Washington D.C. Lowe, P. (2012). What is Normal? Address to the Australian Business Economists Annual Dinner, Sydney, 5 December Vallence, C. (2012). Foreign Exchange Reserves and the Reserve Bank's Balance Sheet. RBA Bulletin, December, 57–63 Read More