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Contracting Blog

The importance of Exchange Rates and the factors affecting them

19/05/2014


People who do not go abroad could go their whole lives without concerning themselves with exchange rates.  Certainly this would be a simpler world, however this is not the case for contractors who work abroad.  When you work in a foreign country suddenly exchange rates become very important indeed.

Imagine, if you will a first time contractor being offered a job in the oil industry in Iran at a weekly rate of 3000 Iranian Rials.  The immediate reaction might be that this is a well-paid position indeed, however scratch the surface and you would quickly see that this amounts to approximately 75 pence a week!

The importance of exchange rates also increases with how much time you spend travelling back and forth between countries.  Changing enough cash to ensure that you have plenty of spending money during your sabbaticals suddenly becomes a priority and many people find themselves watching the exchange rates to convert at just the right time to make the most of their money.

So with the exchange rate playing such an important role we have taken the time to summarise the factors that can affect this to help you keep abreast of significant trends.

Inflation
Countries with lower inflation exhibit an increase in their exchange rates, whereas countries with high inflation will see their exchange rate decrease. 

Interest Rates
These are often used to exert influence over exchange rates.  Higher interest rates attract more foreign capital and therefore the exchange rate increases.  Low interest rates will cause a decrease in the exchange rates.

Current Account Deficits
This is the balance of trade between a country and its trading partners.  A deficit means that a country is spending more on foreign trade than it is earning, so is therefore borrowing from foreign sources.  This will cause the exchange rate to lower until domestic goods and services are so cheap that foreigners are purchasing these and residents are also choosing these as opposed to the expensive foreign imports.

Public Debt
Large debt causes inflation.  This ultimately means that once the inflation is high enough the debt will be paid off with cheaper currency in the future and as we can see above high inflation decreases the exchange rate.

Terms of Trade

This is the ratio between import and export prices.  This is closely linked to the current account.  If the price of a country’s exports is increasing when compared to that of its imports then its terms of trade has improved.  This will result in an increase in the exchange rate whereas a rise in the price of imports will result in a decrease.

Political/Economic Stability
If the political or economic situation of a country is in turmoil then this greatly affects foreign investment as investors tend to seek stable countries with strong economic performance.  The more foreign capital the higher the exchange rate and vice versa.

A low exchange rate means that when you exchange your money to return to your usual resident country you will usually end up with a lower amount than anticipated, however, when you exchange this to return back to the country that you are contracting in this can leave you with a big wad of cash and a smile on your face, so when you live in both worlds it is not always bad news!




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