Factors Infleuncing Fluctuations in the Rate of Exchange

The equilibrium rate of exchange is the normal rate below and above which the market rate of exchange fluctuates. There are a number of influences, which may cause fluctuations in the rate of exchange, either acting singly or in collaboration with others. Fluctuations may due to the combination of the following factors:

Market Influences

Market conditions are those influences or factors that affect the demand for and supply of foreign currencies in the short period. They include

Trade Operation

These operations include exports and imports i.e., the flow of goods from one country to other. If the exports of a country exceed its imports, it means that the demand for the currency of this country will rise because foreign merchants will buy this currency to settle their debts. Thus, exports increase in the demand for a currency will change the rate and it will make the rate more favourable to the creditor nation. Just the reverse will take place when the imports of the country exceed its exports.

Stock Exchange Transaction

These include investment and speculation in international securities, payment of interest and dividend on loan and investments, and repayment of loans raised by one country to another. They affect the demand for and supply of a currency and hence its rate of exchange.

Banking Operations

These include the investment of funds made by the bankers of one country in other countries, issue of circular notes, letters of credit, arbitrage operation i.e., buying and selling of foreign currencies with a view of making profit. If drafts are being sold by a bank in India to foreign centre, the demand for that foreign currency will increase and its rate of exchange will go up. The buying of bills of exchange by bankers is of very great importance as it affords them a consignment means of utilizing their surplus funds. Bank rate is a very strong weapon which also influences the rate of exchange. If the bank rate in India has been raised, it will certainly attract funds from other centers. Consequently, the demand currency will rise and the value will go up. Just the reverse will happen when the bank rate falls in India.

Government Financial Operations

Under this category, are included repatriation payments and loans given by one Government to another during the period of war. Such payments and transfers affect the demand for and supply of foreign exchange.

Speculative Influence

Serious fluctuations are also caused in the rate of exchange by the sale and purchase of foreign currencies by speculators. The speculative activity depends upon the certain factors like rumors of war, inflation, natural calamities, budgetary position etc.

Currency Influence

These refer to long period influence, which affect the rate of exchange because they modify the purchasing power of currencies. The depreciation and debasement of a currency affect its rate of exchange. If the currency has been inflated (over issue of currency has taken place) in the country funds will begin to move out i.e., flight of capital will take place; and its rate of exchange in relation to other currencies will tend to be unfavourable. Deflation will undoubtedly raise its rate of exchange.

Iii. Poliitical Conditions

Satisfactory political conditions constitute another important factor that attracts foreign capital towards a country. A country which enjoys a political stability creates condition favourable for the investment of foreign capital. When the funds are invested into a country, demand for a currency of that country increases as a result of which the rate of that currency becomes more favourable.