Factors Affecting the Forex Market

The exchange value of a currency, or the rate of exchange, fluctuates with changes in demand and supply. The factors which affect the demand for and the supply of a currency are many and varied. There are some factors which operate in the short period and have influence on day-to-day- fluctuations in rates of exchange. The commercial and financial relationship between trading countries is now extensive and payments on various accounts fall, due for early settlement. These payments constitute the short-term demand and supply in regard to currencies. There are, however, changes in currency and credit conditions and political and industrial conditions which have their influence on exchange rates only in the long period.

The factors affecting Forex market may be summarized thus:

Short Term Factors Affecting the Forex Market

1. Commercial Factors

One of the important factors influencing the demand for and supply of currencies is trade in merchandise, i.e., imports and exports of goods. The demand for the currency of a country arises from exports of goods by the country B. An increase in a country’s imports due to an increase in demand, a reduction of tariffs, or an export-promotion drive by exporting countries raises the demand for and exchange value of currencies of exporting countries in the exchange market of the importing country.

In other words, the exchange value of the currency of the exporting country falls. An increase in exports has the reverse effect.

There are, in addition, many invisible items of payment which create debts and, therefore, need for settlements through purchase and sale of exchange. The residents of a country have to pay and receive from foreigners for services of various kinds, such as transport, banking, insurance, etc. Premium, brokerage, commission and other risks of payments are made, or received by trading countries. Exports of equipment, enterprise and technical skill by advanced countries to underdeveloped countries has assumed considerable importance during recent years for which the exporting countries receive payments in the form of profits, dividends, foreign royalties and other charges.

The effects of lactation’s in exchange rates are either favorable or adverse and healthy or unhealthy,  depending upon the ultimate result and influence of the fluctuations on the balance of trade and payments position between the trading partners directly or indirectly. To avoid the adverse effects of rate of fluctuations and ultimate losses or gains to either of  the trading partners, some of the countries, especially East European countries, have opted to enter into Bilateral Trade Agreements wherein the payments are settled through exchange of goods and services instead of making the payments in currencies of either of the countries. Such agreements avoid monetary transactions and the countries with lesser foreign exchange reserves can make the use of these scarce commodities to trade with other direct payment procedure countries.

Summing up we can say that the demand for currency on trade account arises on account of the following factors:

  1. The residents of the country have exported goods to other nations for which they have to receive payments.
  2. The shipping, banking and insurance companies of the country render services to other countries for which they receive remuneration.
  3. Entrepreneurs setting up business abroad, and supply technical personnel and managers receive profits and salaries.
  4. Tourists and students coming from abroad spend money in the country.
  5. Besides the regular tourist traffic going from country to country only for tourist interests, here are certain groups traveling on cultural and exchange programmers under various government-sponsored delegations and private visits to fiends and relatives staying in other countries also lead to the need of foreign exchange. In recent years, movement of individuals and groups on these accounts are on higher side, and the overall contribution of the exchanges effecting on these accounts are figuring remarkably in overall balance of payments position under the heading of private transfers.

Similarly factors which are responsible for supply of currency against a demand for foreign currencies are:

  1. Imports from other countries.
  2. Use of services by foreign shipping, banking, insurance and other services, for which payments are to be made.
  3. Payments made as salaries and profits to foreigners not staying in the same country.
  4. Residents of the country going as tourists abroad and for higher education in foreign universities and institutions spend money there.

2. Financial Short-term Factors

International financial operations had important influence on exchange rates when movements of foreign capital and speculative dealings in foreign exchange are not controlled. The influence of short-term factors is much-less in present-day conditions.

Financial operations include, among other transactions, short period movement of funds between two or more countries. If rates of interest are higher at one center than at another, the tendency would be for banks and other institutions at the place where the rates are low to use some of the funds for investment in bills the other center. In rates of interest in a country rise due to a rise in the central bank or some other reasons, there is a flow of short-term funds to the country and the demand for its currency and the exchange value of the currency rises in the exchange markets of other countries. The reverse happens if there is a fall in interest rates. Funds are also exported for short-term investment in other countries when the exchange value of the currency is expected to fall. This is purely a speculative operation.

Stock exchange transactions do play an important part in influencing exchange rates when imports and exports of capital are permitted. Residents of country sometimes buy a foreign currency in order to purchase securities on the stock exchanges of that country. These purchases may be for genuine investment or may be for speculative purposes. This is likely to happen when industrial prospects in the country of investment are bright and the prices of securities are expected to rise. In the event of poor economic and industrial outlook investments in that country are repatriated and the demand for its currency falls.

Another financial factor is movement of funds from one center to another by banks. Banks maintain balances at different centers and the volume of maintaining the balances at a center depends on the economic and industrial state of the country. When the outlook in this regard is bright, remittances to the country increases and the banks acquires larger balances in that country. To pay for the foreign currency with increased demand, the value the currency changes the event of a poor outlook, banks shift their holdings to centers where the outlook is favorable and in such circumstances the exchange value of the currency depreciates.

In recent years movement of funds from one country to another has been taking place on government account due to external assistance, aid and line of credits. Untied States particularly has been giving large financial assistance to other courtiers. This has increased the supply of funds in the aid-receiving countries.

An exchange rate is sometimes affected by the disbursements and repatriation between countries for their debt settlements. When the economic outlook for a country has a stronger position in relation to others, and foreigners who have to make remittances to the country do so before the value of the currency rises higher. The demand for the currency rises further and its exchange value becomes more country is poor, the currency shows a downward trend in exchange markets. There is a tendency for the residents of the country to transfer their funds abroad and for foreigners to withdraw their funds. The currency, therefore, weakens further.

Financial, operations also arise form what are known as “Arbitrage Operations”. Arbitrage means the simultaneous buying and selling of any commodity at two or more centers, used by a discrepancy in the price differentiation at different places. Arbitrage in stocks or money or exchange on a international scale has an important influence n exchange rates. For example, taking price and exchange rates into account, an international operator may find that the price of a particular security which is bought on stock exchange at two centers in different countries differs. He, therefore, enters in a purchase deal at the center where the price is low and simultaneously enters into a sale deal at the one where the price is high. This necessitates remittance from the latter center to the former, causing the exchange rate to change in favor of the former and against the latter.

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