Structural factors

Inflation rate. The higher the inflation rate in the country, the lower the exchange rate of its currency, if other factors do not oppose it. Inflationary depreciation of money causes a decrease in purchasing power and a tendency to drop their exchange rate to the currencies of countries where inflation is lower. This trend is usually observed in the medium and long term.

The dependence of the exchange rate on the rate of inflation is especially high in countries with a large volume of international exchange of goods, services and capital. This is due to the relationship between exchange rate dynamics and relative inflation rate when calculating the exchange rate based on export prices. World market prices are a monetary expression of international value. On the other hand, import prices are less acceptable for calculating the relative purchasing power parity of currencies, since they themselves largely depend on the dynamics of the exchange rate. The wholesale price index is acceptable for such a calculation only for industrialized countries, where the structure of wholesale domestic trade and exports is largely similar. In other countries, this index does not include many exported goods. Such a calculation based on retail prices can give a distorted picture, as it includes a number of services that are not the subject of world trade. Ultimately, the alignment of national monetary units in the world market occurs spontaneously in accordance with real purchasing power.

International capital overflows associated with changes in interest rates also have a significant impact on the dynamics of exchange rates (interest rate level). On the one hand, changes in interest rates in the country affect, ceteris paribus, the international capital movement, primarily short-term ones. As a rule, raising the interest rate stimulates the inflow of foreign capital, and its reduction causes an ebb of capital, including national ones abroad. Interest rates, on the other hand, affect the operations of foreign exchange markets and loan capital markets. When conducting operations, banks take into account the difference in interest rates in the national and global capital markets in order to generate profits. They prefer to receive cheaper loans in the foreign loan capital market, where rates are lower and place foreign currency in the national credit market if interest rates are higher on it. The main role in the dynamics of the exchange rate in connection with changes in interest rates is played by the so-called “hot money” – international money free for investment and currency speculation.

The relative increase in interest rates in a given country as a result of, for example, pursuing a restraining monetary policy contributes to the influx of “hot money” into it and the appreciation of its currency. Investors and speculators, wishing to extract income from high interest rates, convert their assets from national currencies into the currency of a given country, increasing demand for it in the foreign exchange market.

“Hot money”, due to the spontaneity of their movement between countries, can move from a country as quickly as they came to it as a result of changes in the economic situation, exerting speculative pressure on the currency of a given country and weakening it.

Strengthening the national currency rate is likely to not happen if the increase in interest rates is associated with increased inflation or an increase in the state budget deficit. Influencing the supply and demand of the currency, the balance of payments affects the level of the exchange rate, causing its deviation from the ratio of currencies from their purchasing power. In fact, the exchange rate expresses the state of international payments and interest rates in various markets. This is due to the implementation of international settlements through the sale of the necessary foreign currency by participants in interethnic economic relations. The active balance of payments (excess of revenues over payments) contributes to the appreciation of the national currency, as there is an increase in demand for it from foreign debtors. The passive balance of payments (exceeding payments over receipts) tends to decrease the national currency, as debtors sell it in exchange for a foreign one to pay off their external obligations. Exchange rates are keen on current account information. As noted above, the current account deficit is an indicator of the growth in demand for foreign currency, as there is a reorientation to the purchase of goods and services in foreign currency. The reaction of the foreign exchange market to the official report on the current account deficit is expressed in the depreciation of the national currency.

However, the current account deficit does not always indicate a weak currency. If this deficit reflects the desire of foreigners to have more of this currency for international operations, selling more goods and services to the country, in which case its rate increases.

Exchange rates are extremely sensitive to the expectations of economic agents regarding their future dynamics. When forecasting exchange rates, it is necessary to take into account the size of the planned state budget deficit and how to cover it, the policy of central banks regarding future money supply growth. If the government has planned a significant budget deficit, and the emission method of covering it is inevitable, or the monetary policy of the Central Bank is broad, most likely, depreciation of the national currency can be expected, since declared policies will inevitably lead to inflation.

Proposals for future changes in exchange rates affect decisions made by companies regarding the purchase and sale of foreign currency. As a result, calculations on foreign trade operations are accelerated or delayed, which affects the dynamics of exchange rates. So, if the value of the national currency is expected to fall in relation to other currencies, importers who must pay for goods in foreign currency will pay immediately without resorting to loans, and will import more goods until the fall in the price of the national currency. Stock creation policies will very soon generate high demand for foreign currency from importers in exchange for national currency.

Exporters, in turn, receiving payments in foreign currency, will not rush to exchange for the national currency, waiting for the latter to fall in value. Thus, in anticipation of a depreciation of the national currency, importers seek to expedite payments to counterparties in foreign currency so as not to incur losses when increasing its exchange rate. When strengthening the national currency, on the contrary, their desire to delay payments in foreign currency prevails. As a result, the combination of acceleration and deceleration of calculations by increasing imports and slowing down exports will worsen the trade balance and accelerate currency depreciation.

Currency fluctuations also depend on the expected government exchange rate in relation to private property, taxes, trade and currency restrictions, which characterizes the degree of confidence in the currency in the national and world markets. It is determined by the state of the economy and the political situation in the country, as well as by the factors discussed above that affect the exchange rate. Moreover, not only data on the rate of economic growth, inflation, the level of purchasing power of the currency, the ratio of supply and demand of the currency, but also the prospects for their dynamics are taken into account. Sometimes even the expectation of the publication of official data on trade and balance of payments or election results affects the ratio of supply and demand and the exchange rate.