THE DETERMINANTS OF NOMINAL EXCHANGE RATE
Nominal exchange rates are the number of units of currency from a country that can be exchange from another country according to their given value, given value is computed according to their economic position which may change in time. There are many factors that can determine the changes of exchange rate since currency has an equal amount from any other parts of the world therefore its determining factors is the source of it.
Understanding the daily increase and decrease of currency cannot be predicted in a single determinant but through economic variables of constantly changing phase. Countries all over the world are mostly included and interrelated with each other, that is why changes from a currency of other country can also change the other or vice versa. In simple term the nominal exchange rate can be determine by the country’s supply and demand factors which include the following:
1. Difference in inflation – Inflation is cause by a rising price of commodity in a certain country. A nominal exchange rate can easily be determined by a countries exchange rate through differences in inflation. A country with minimal inflation rate can expect a high currency exchange like Germany and Switzerland but on the other side, a country with a rising inflation rate like Philippines can expect a low currency exchange rate therefore purchasing power of a low inflation rate countries also increases while the country with high inflation causes them to have a low purchasing power.
2. Difference in Interest rate – This a charged rate for a borrowed capital that is paid annually. A certain country who borrowed money from International Monetary Fund or World Bank needs to pay their interest rate aside from their principal debt. For example a country like Rwanda borrowed 1 million dollars that they need to pay within ten years. Therefore they will be given for example a 10% interest rate which is 100,000 dollars that they need to pay annually before paying the principal amount. This situation may cause an increase in price of basic commodity and therefore high inflation which causes a nominal or low currency exchange rate of a particular country.
3. Current account deficit – This is a balance of trade within a country and its partner and how they interact and exchange goods and services. Current account deficit simply means a low export of domestic product and more imports of goods from other country If a particular country spends more on foreign trade than generating revenue, they may lack capital that may force them to borrow money through foreign sources that makes a deficit, therefore the country may experience high inflation rate. This will make the country in deep burden and domestic asset may go to foreign ownership somehow makes it a part of their payment.
4. Government or public debt – Countries may need funding for their project in construction and industrialization that results in government debt to foreign country such as World Bank or International Monetary Fund. Somehow their project can administer domestic growth; international perception would be a country in debt. If this particular country may not be able to suffice their payment in time they may be force to borrow more and therefore decreasing a chance for foreign investor. High government indebtedness may produce a negative effect to the international market and therefore disrupt investors that may affect their production therefore large debt may attract high inflation that lower their currency exchange rate.
5. Political Stability and Performance – Foreign investors can be easily attracted to seek highly established countries and those who have gather a strong political trust, Political turmoil, peace and order even environmental occurrences may cause a loss of confidence in investors and therefore low exports and dollar revenue generation that causes a country to fall from domestic and international trade.
6. Import Export determinant – If the country’s export rises more than imports then the country’s trading may be improved and they can generate bigger revenue that may demand a currency increased value and therefore decreases inflation which in turn produced a stable economic perspective and higher trading. But if Import rises more than export then you can expect another economic decline and low currency exchange rate.
In an overall perspective the exchange rate determining factor in a country’s economic condition has a number of diverse and complex factors; it is the government and the people who are liable in recovering and empowering their country to be productive in enriching their investment and raising their position through international and foreign trade. They are the only one who knows and understand their position towards economic performance and growth.
Credit:ivythesis.typepad.com
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