What is a Foreign Currency? Which Factors Determine the Exchange Rate?

What is a Foreign Currency? Which Factors Determine the Exchange Rate?

What is a foreign currency? Which factors determine the exchange rate? This week, we'll cover what a foerign currency is with contributions of Investing.com.

All currencies other than a country's local currency are called "foreign exchange". "Exchange rate", on the other hand, is the value of a foreign currency against the local currency, in other words the number of times. To be concrete, Turkey’s native currency is the Turkish lira, and all currencies other than the Turkish lira are foreign currency. The value of currencies other than Turkish Lira against TL is the exchange rate.   Which Factors Determine the Exchange Rate? The factors that determine the exchange rate can be listed as supply and demand, interest, inflation and economic stability. Supply and Demand: If a country's foreign exchange inflows are rising - this happens with exports and external debt - there will be an abundance of foreign exchange in the country, that is, foreign exchange supply will be high. If the foreign currency supply is high, the exchange rate falls in that country. If the opposite happens, that is, if imports are high and foreign debts are paid in foreign currency, the amount of foreign currency in the country decreases, which increases the demand for foreign currency and causes the exchange rate to rise. Interest: Domestic and international interest is another factor that determines the exchange rate. If the domestic interest rate is above the global interest averages, the more guarantee of the interest yield than the exchange rate decreases the demand for foreign currency. In the other case, if global interest rates, that is, interest rates in other countries, are higher, this brings along an increase in the exchange rate. Inflation: If the inflation rises, the demand for foreign currency increases as a protection against the low purchasing power of the domestic currency. You can click here to get more detailed information on the subject. Economic Stability: If there is no sustainable growth in economic growth items such as employment, growth, current account deficit and inflation, especially if the inflation target is not achieved, this situation raises a concern against the domestic currency. As a result, the problem of economic confidence will increase the demand for foreign exchange.   Let's take look at the change of Turkish Lira over the years in terms of USD/TL rate: Between 2002 and 2013, the dollar exchange rate was below the 2.0 level, followed by a balanced pricing in a narrower band. Factors such as global crises, expansionary policies and increased risk appetite played a role in this pricing. On the other hand, factors such as the global tight monetary policy of the FED, the rise of the dollar in the world, the shift of investments from risky places to safer places were determinant in the movements in 2013 and after. In addition to global changes, some balances started to change and deteriorate domestically. Increasing political and geopolitical risks in domestic pricing started to determine the direction of pricing.   At this point it is necessary to add another title:   Political and Geopolitical Developments: Undoubtedly, this topic is decisive in every country and can affect the world from the local. These developments, which have increased all over the world in recent years, greatly affect the domestic pricing. With the effect of political and geopolitical developments in 2013 and after, the rise in the exchange rate gained momentum and new records were recorded every year. In 2018, we witnessed an increase in the demand for foreign currency due to the deterioration in economic indicators, especially inflation. In 2020, the exchange rate reached a new record level with the effect of expansionary approaches in monetary and fiscal policy. In the weeks before this article was published in February 2021 — after the policy turn of November 2020, the central bank's guidance to the markets and a high global risk appetite — the Turkish lira recovered roughly 18 percent from its record low against the dollar: the USD/TRY rate, which had exceeded 8.50 in November 2020, was back near 7.04. Those are the levels of early 2021 and nothing more; a live rate is not something an explainer can carry.   What is the Exchange Rate Policy? While the central banks and the government determine the exchange rate policy together, the implementation of the determined policy is under the authority of the central bank. In Turkey, floating exchange rate has been implemented since 2001.   What is a Floating Currency? The floating exchange rate is the price determined according to the supply-demand balance in the market, which the Central Bank does not intervene directly. In other words, the Central Bank does not have a direct exchange rate target, but the bank may take some measures to prevent sharp volatility in the domestic currency (this may be a rise or fall). These measures include interest, swap limits, repo auctions, etc. The main purpose of the foreign exchange policy, which is included in the monetary policy of the Central Bank, is price stability. In order to reduce financial stability risks, the Central Bank can take certain steps to reduce risk without directly interfering with the functioning of the exchange rate in the market.       Source:

Continue in the iEconomy Academy: Interest and central banks, What a stock index is. Terms used in this lesson: Current Account Deficit, Monetary Policy. Upcoming dates: interest rate decision calendar.