Following are the factors which are responsible for affecting the foreign exchange rate:
(i) Import & Export : If domestic import is more than the export, it increases the demand of foreign currency. Due to this, foreign exchange rate comes in favour of the foreign currency. Hence, it increases the rate of foreign currency. In opposite situation, rate of foreign currency declines.
(ii) Capital investment: When domestic investors invest capital in foreign countries then the demand of foreign currency increases and exchange rate also increases and when foreign investors invest in the domestic economy then they demand for domestic currency. This helps in increasing the rate of exchange of domestic currency.
(iii) Sale and purchase of shares, and bonds : If the people of one country purchase the shares and bonds of foreign countries, it increases the demand of foreign currencies and decreases the value of domestic currencies. In a converse case, if people of one country sell the shares and bonds of foreign countries, it increases the rate of domestic currencyin comparison to foreign currency.
(iv) Bank rates: Due to the increase in bank rates, foreign investment comes into domestic country for more interest rates. It increases the supply of foreign currency. As a result, exchange rate of foreign currency goes down and value of domestic currency goes up.
(v) Speculation: If a speculator thinks that the rate of exchange of particular country’s currency will go high in the future, he starts to purchase such currency. If he speculates that the rate of particular country’s currency will go down in the future, he starts to sell that currency. This speculation affects the exchange rates in the market.
(vi) Inflation and Deflation: In case of inflation, value of domestic currency goes down. In this situation, foreign currency flows outwards. This increases the demand of foreign currency and value of foreign currency goes up in comparision to domestic currency. In the converse situation of deflation, the value of the domestic currency goes up and for earning financial profit foreign currency flows in.
