Implications for an Economy of a Rising Exchange Rate Essay

Implications for an Economy of a Rising Exchange Rate - Essay Example There are two types of foreign exchange rate, the spot exchange, and the term forward exchange rate. The first is defined as the rate that is currently applicable, while the latter is defined as the rate that is currently quoted and used for trading. Foreign exchange rates are determined by either a fixed rate, or a floating rate regime. A fixed rate regime of foreign exchange means that the value of the currency against a foreign currency is determined by the government through its central bank. A floating rate regime determines the value of the currency based on the dictates of the market, hence, through supply and demand principles. The private sector largely determines the appropriate exchange rate in a floating rate regime. Foreign exchange is among the three frequently used indicators to assess the health of an economy. The other two indicators are the interest rate and the inflation rate. However, it is said that foreign exchange plays a vital role in the country’s level of trade, which is critical to most free market economy in the world. Such importance has made its role in the economy critical, and with its impact, it has thus became the â€Å"most watched, analyzed, and governmentally manipulated economic measure†. ... A large, consistent government deficit, crowding out domestic borrowing, 5. A strong domestic financial market. 6. strong domestic economy relative to weaker foreign economies, 7. No record of default on government debts, 8. Sound monetary policy aimed at price stability, and 9. Political or military unrest in other countries. A combination of the above conditions will give rise to a stronger currency. Some of them may be construed as a sign of good economic housekeeping. But who directly benefits from a strong currency, and who will eventually lose out if a strong currency prevails over a longer period of time? How does a rising foreign exchange rate, then, make its impact on the economy? Foreign exchange rate would move in two directions. It moves either up or down (an appreciating or a depreciating currency). In either direction, however, it impacts the economy with some sectors being positively affected, and some sectors being negatively affected. It is therefore a question of ba lancing or mitigating its impact by government regulators in order to as much as possible keep all stakeholders happy. A rising foreign exchange rate, as stated, primarily affects a country’s exports by making them more expensive for other countries to buy. They will become more expensive to importing countries and are therefore less competitive compared to other countries. Economies whose growth is generally export-led and are relying mainly on income from exporting goods and services will be highly affected by a continuously appreciating local currency. It is the exporting sector of the economy who bears the brunt of an appreciating currency, where their produce have become less competitive in the global market relative to other similar commodities from other countries. Thus, a