In international trade the most elementary aspect is the payment for the value of goods or services by one country to another. All the countries in the world operate with their own currencies. The value of a particular country’s currency in relating to currencies of other countries is termed as foreign exchange rates. Considering the huge number of currencies involved, international trade is conducted in three or four of the most stable and strong currencies of the world. The US Dollar, Pound Sterling and the Euro are accepted as the currency of transaction s by many countries. The US Dollar has the distinction of being accepted for international trading transactions by all countries and banks all over the world. It has been able to hold on to the number one position even with a weakening US economy.
International trade has been practiced for several centuries but only from the beginning of the last century it has become necessary to fix a foreign exchange rate for different currencies. The present practice among different countries is to fix its foreign exchange rates in respect of the US Dollar, Euro and Pound Sterling and also with the currency of any other country with which large volume of trade is done. It is with the purpose of avoiding confusion with multiplicities of currencies that the European Union has embarked on single currency in Europe for many of its willing members. The Euro is traded with a market rate compared to that of US Dollar. Because of the huge volume of international trade foreign exchange rates have become relevant in the case of all countries with particular reference to US Dollar, Euro etc.
The foreign exchange rates get determined in the international market depending on the demand for a particular currency for trade transactions. Demand and supply is variable and subject to change because of several factors. As a result exchange rates of various currencies fluctuate. For a stable currency such fluctuations affect the country’s currency being compared to it. Wide fluctuations occur frequently making the situation volatile for the currency. The currency that is in great demand is valued higher and it appreciates. Similarly depreciation happens in the case of currencies whose demand goes down. To offset such volatility countries resort to devaluation on a voluntary basis hoping that it will help in boosting their exports.
The foreign exchange rates are also determined by the inflow of foreign exchange into a particular country causing a natural decline in the demand for that currency. A case in point is the remittances by nationals working in other countries by way dollars thus improving the foreign exchange reserves of that country. Heavy industrialization giving plenty incentives to foreign investors also bring in investment and foreign currency boosting the stability of the country’s currency. This investment may be direct with the foreign company directly involved or it may be in the form of stocks and shares of the local companies. Either way the host country benefits with a steady inflow of foreign currency. Governments take several measures to prevent heavy volatility of the currencies exchange rates.