Strength of Currency
Currency represents money in the form of paper notes, coins. When you buy something, you say its value in currency like “I bought a Louis Vuitton handbag worth $1200”. You don’t say, “I bought a Louis Vuitton handbag worth a Samsung LED TV”. We are going to read what makes currency strong and benefits of strong and weak currency, how to know the strength of currency.
The symbol on currency represents the value of money it is going to be exchanged for. For example, Rs 100 note in India has a sentence “I promise to pay the bearer a sum of Rs One Hundred only” signed by the Governor of the Reserve Bank of India. It is used to buy a product worth Rs 100.
Value of currency is purchasing power. Value of money is determined by the demand and supply of it just like other things in market.
When one country’s currency is worth less than of another country, that does not mean that country is not strong or its currency is not strong. Strength of currency can’t be only decided on exchange rate. Currency is strong when its value increases against another country’s currency over many years. For example, Japan’s currency is strong though its value is less than American Dollar.
Sometimes, you see on TV or read in newspaper that value of INR changed against USD.
Why does the value of currency change?
There are many factors which affect the value of currency. Some of them are as follows:
- Interest Rate: When interest rate is high, foreign investments are more as foreign investors get high return. This interest rate and money supply are controlled by government of country. Money supply means the total amount of money circulating in country. If money supply is high then the value of currency will be less against foreign country. High money supply means lower interest rate as demand is lower and supply is more. And low interest rate means investors get low returns so it drops the value of currency.
But sometimes, government choose lower interest rate as lower interest rate means more borrowing and more spending. So, economy of country grows.
- Inflation Rate: Inflation refers to the rise in the prices of most goods and services which we use daily like food, clothing, transport, etc. If inflation rate goes too high, it means demand is more and supply is lesser. It causes currency depreciation.
Inflation rate with other factors can also affect import and export of country.
- you are exporting a machine at Rs 3000 which has the manufacturing cost of Rs 2500. You are earning Rs 500 behind one machine. The cost of similar machine manufactured in other country is Rs 3100(converted in INR). Next year, if inflation rate is 10% then the manufacturing cost of bedsheet would become Rs 2750. So, you would earn Rs 250 behind one same machine. To earn the same income, you have to raise the selling price of machine. And if you make it costly then the country which was buying from you would buy from other country which is giving at lesser rate. So, inflation rate can affect your export.
- If you want to buy a laptop which is costing Rs 50000 in your country and it’s cost other country is Rs 52000. Next year if inflation rate is 10% then the selling price of same laptop would become Rs 55000. People will prefer to import it from outside India. It will affect the Indian market.
- Stability: A strong government with stability can attract foreign investors to invest in country so the value of currency gets appreciated because of the high demand. A strong and stable economy means moderate degree of spending, low unemployment, an increasing GDP (Gross Domestic Product).
Monetary and fiscal policy promote the value of currency. Monetary policy refers to central bank activities that directs the quantity of money and credit in an economy. And fiscal policy refers to the government’s decision about taxation and spending.
If government is unstable then it affects the economy of country. Unstable economy discourages foreign investors to invest in country.
Benefits of weak currency:
If currency of country is weak means people can earn more profit by exporting. For example, suppose 1 USD = Rs 50 and if you sell a t-shirt at USD 60, you earn Rs 3000 and if the value of currency goes down (1 USD = Rs 55) then you can earn more profit (Rs 3300).
If the currency of country is weak then import is expensive. For example, suppose 1 USD = RS 50 and if you are buying a LED tv from other country at price USD 1000, you are paying Rs 50000. But if value of currency goes down (1 USD = Rs 55) then you will have to pay Rs 55000. So, import becomes expensive and people buy products from domestic market.
If the currency of country is weak then people of other country will buy more products from your country. For example, suppose, the value of 1 USD= Rs 50 and the value currency of other country is higher as compared to your country. Then cost of manufacturing t-shirt would be lower in your country than other countries so people of other countries will import products from your country at lower rate. It increases the demand of goods and so it increases the jobs in your country.
Because of the above reasons, many countries keep their currency value low.
Benefits of strong currency:
If currency of your country is strong then you can import products at cheaper rate. Because, as I explained in above example, if the value of currency is low then manufacturing cost is also low. So, if your currency is strong then manufacturing cost is also high but then you can import products from other countries which has lesser manufacturing cost and selling price.
If currency is strong then your holiday abroad is cheaper. For example, if a holiday in Italy costs you 4000 USD and value of currency is Rs 50 then it costs you around Rs 200000. But if currency becomes stronger (1 USD = Rs 40) then you will have to pay Rs 160000. And in opposite case, if people of America want to come to your country for vacation and the cost of vacation is around 3000 USD, American will have to pay Rs 120000 (1 USD= Rs 40). So, more tourists will come and create job opportunities.
Strong currency can keep inflation rate controlled. So, the controlled inflation rate and high employment can increase demand of your currency.