Posted by Anjali Kaur on Nov 19, 2020

Factors affecting foreign exchange

The factors affecting foreign exchange includes foreign direct investments, import duty, etc.

 Let’s understand this topic in detail.

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1. Increase in foreign direct investment (Increase in the supply of the foreign exchange)

When there is an increase in FDI, it means there is an increase in the supply of foreign exchange as people from abroad are investing more in the domestic country.

This will cause a fall in the rate of foreign exchange and the domestic currency will appreciate. With the appreciation of the domestic currency, imports will rise.

2. Sale of foreign exchange by the Central bank (Increase in the supply of foreign exchange)

By selling foreign exchange in the international money market from its reserve. The central bank can increase the supply of the foreign exchange in the international market..

Therefore, the supply curve will shift to the right. Foreign exchange will fall, there will be an appreciation of the domestic currency which will make import cheaper.

3. Increase in the import duty

An increase in the import duty causes a rise in the price of imported goods, that is, there will be reduced in the demand for foreign exchange.

The rate of the foreign exchange will go down, the domestic currency will appreciate.

Affect of the appreciation of domestic currency on imports

Appreciation means an increase in the value of the domestic currency against foreign currency. So foreign currency will now be exchanged for domestic currency. For example, less INR is needed to buy goods worth 1 USD.

So, the imports will rise exports will fall.

Affect of the depreciation of the domestic currency on imports

When a domestic currency depreciates, the value of the domestic currency in terms of foreign currency falls, that is, domestic goods become cheaper in terms of foreign currency.

For example, INR 80 = 1 USD, accordingly exports will rise and imports will fall.

1 must know, to avoid confusion:

Depreciation of foreign currency = appreciation of the domestic currency

Appreciation of foreign currency = depreciation of the domestic currency

Foreign exchange rate rises in India = Depreciation of the domestic currency.

Thank You for reading.

You can read the related post on macroeconomics:

The foreign exchange rate

The Budget Expenditure

The Budget Deficit

The Government Budget

Working of the Investment

Investment Multiplier

Types of Employment Equilibrium

Concept of Short-Term Equilibrium

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