Factors Influencing Exchange Rate

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Each country has its own currency that is utilized as the primary mode of payment for various goods and services within the borders of the nation. For e.g. the currency in India is the Indian Rupee; the currency in the United States of America is the US Dollar; the currency in Japan is Yen etc. In a self-sufficient global scenario, there would be no pressing need for exchange rates. Each nation would function as if no other nation existed. The countries would manufacture goods and services that would be consumed only by the inhabitants of the nation. If a country were devoid of a certain resource, it would have no scope in that particular field. Global trade would be non-existent in such a scenario. But fortunately, such a scenario is purely…show more content…
In this section, the various factors that generally affect the exchange rate of a nation involved in global trade are discussed.

As discussed earlier, the fluctuations in exchange rate primarily depends on the supply-demand dynamics. These dynamics are caused by an array of factors.

i. Economic Data: The economic data of a nation is vital for global trade to develop. Crucial markers in the economic data reported include the Gross Domestic Product (GDP) which indicates the value of the total goods and services produced within the geographical boundary of the economy; the Index of Industrial Production (IIP) which outlines the growth of various critical sectors of the economy such as mining, electricity and manufacturing; the Consumer Price Index (CPI) which entails the inflation rate governing the economy; Unemployment Rates; the Institute of Supply Management (ISM) Purchasing Managers’ Index which surveys the economic health of the manufacturing sector; and International Trade Statistics. These indicators directly influence the exchange rate of an
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Speculation: The economic or political scenario of an economy leads to speculation on the value of the currency. Speculation that the value of the currency will decrease results in the selling off of the currency, which lowers its value. The recent example of uncertainty regarding the political future of Scotland within the United Kingdom resulted in fear of instability in the Pound Sterling. Consequently, the value of the Pound Sterling continuously fell on account of speculation till the final voting day.

vii. Interest Rates: Interest rates in particular have a large bearing on the exchange rate of a country. When the interest rates on deposits are low, investors tend to prefer transferring their deposits to other countries that offer higher returns. This effect is clearly seen in the fluctuations of the exchange rate when there is a huge exodus of capital out of an economy and into another economy. The interest rates in the US have a strong effect on the exchange rate in India. This will be analyzed in detail in the subsequent

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