Meaning and Causes of Currency Appreciation

The exchange of currency to deliver a product or service facilitates every international transaction. When the currencies used by the two countries are identical, such as Euro in the European Union, the transaction can be quite straightforward. However, complications arise when trades have to be made between two currencies that are not accepted by both countries. For example, the Euro in the European Union and the Dollar of the United States.

The Foreign Exchange facilitates currency exchanges. The price of one currency is determined by its demand and supply. The demand and supply of a currency determine the price. It can also vary over time. The gain or loss in currency prices tells us when a currency has appreciated or fallen.

What is Currency Appreciation and Currency Depreciation?

We will use a USD/INR currency pairing for ease of discussion. The base currency is the United States Dollar (USD), and the quoted currency is Indian Rupees. Let's assume that the current market rate is USD/INR = 75. To buy $1, you would need Rs. 75, or Rs. 75 if you sell for $1 75 on the exchange

Currency Appreciation:

When the base currency becomes more costly in the currency pair, a currency is said to appreciate. quote currency. For the USD/INR pair, $1 equals Rs. 75 was the previous value, and now it is $1 = Rs. The Dollar has appreciated in value since 76. Indian rupees. A person who wants to purchase $1 will need to spend more rupees to get the same amount.

Currency Depreciation:

A currency can also depreciate if the base currency becomes less expensive. Quote currency in the currency pair. Similar for the USD/INR pairing, where $1 = Rs. 75 was $1 = Rs. The Dollar has reportedly fallen w.r.t. 73 Indian rupees. A person who wants to purchase $1 will have to pay less rupees and vice versa.

Additionally, one important consideration must be kept in mind when determining the appreciation/depreciation for a currency pair. A pair is one in which the base currency is considered to have appreciated relative to the quoted currency. The quoted currency is then said to have depreciated. The base currency. Take, for example.

One dollar equals Rs. 75 becomes $1 = Rs. 75 becomes $1 = Rs. 76. While the Dollar is believed to have appreciated, Indian Rupees are said to have depreciated in comparison to the Dollar. If $1 = 75 is $1 = 73, the Dollar is said not to have appreciated, but Indian Rupees are said to have appreciated. For every currency pair, appreciation is inversely related to depreciation.

Factors affecting Forex Prices:

Although the foreign exchange rates are determined primarily by the demand and supply for a currency, it is important to understand all other factors, especially for international investors or individuals who engage in international trade. These factors influence the local exchange rate of the country as well as the global exchange rate at a macroeconomic level.

1. Inflation

Inflation reduces the currency's purchasing power. The FX level shows that two countries with different inflation rates will have an inverse relationship to each other's currency strength. If the US is experiencing lower inflation than India, the USD/INR currency pair will appreciate over time. However, INR will decline.

2. Interest Rates

The central bank of every country decides the interest rates for that country. They maintain a healthy balance between the country's economic activities and inflation targets. Imagine the United States Federal Reserves raising its interest rates. Many Indian International Investors would buy US dollars in exchange for Indian rupees to invest in US bonds. This exchange is due to greater demand for US Dollars; the Dollar will appreciate, while the Indian Rupees and vice versa will fall.

3. Public Debt

The Indian Govt. is a vital part of a fast-growing country like India. The Indian Govt. often has to incur large capital expenditures in order to finance various projects. This is a situation where every US investor might be interested in investing in such a project. It will result in greater demand for Indian rupees than USD. This will cause the USD to appreciate and USD to depreciate. In the opposite situation, a government can print money to repay the loan. This will increase inflation.

4. Trade Balance

The trade balance of a country can be summed up as Exports - Imports = Balance. If Imports are greater than Exports, then the country has a positive trade balance. This means that foreign currency is inflowing into the country at a higher rate, which leads to a rise in foreign reserves and a decrease in currency value.

5. Policies

The government of a country can purchase foreign currency during economic downturns, provide fiscal stimulus through printing money, restrict or allow the flow of currency from one country, and balance the flow goods with another country. These capabilities can have a positive or negative impact on the fx rate but they can also ensure economic growth.

6. Speculation

Sometimes the international community's confidence in the currency can affect the currency's value. Imagine a foreign currency holder believing that the USD could decline. They may decide to sell their currency, which would lead to the USD's depreciation, or they might buy the USD if they think it will appreciate over the next few days.