Staff Writer
Understanding the mechanisms and factors influencing foreign exchange rates can be a tricky matter for those outside the industry. Amid talk of financial crisis, possible devaluation of the ruble and rising inflation, The St. Petersburg Times asked local expert Ruslan Abushaev, an analyst at FxCompany, to help decipher the mysteries of the Forex.
What factors affect exchange rates?
The rate or value of any currency is determined by the volume of demand and availability of this currency on the market. In order to buy goods or assets in any country, the buyer must first purchase the currency in which the value of the asset is set. As a result, the higher the demand for goods or services from a certain country, the higher the demand and therefore the value of the currency of that country.
The main figures in currency trade are commercial banks, which either represent clients, exporters or importers, or buy and sell currency in their own names for investment or speculative purposes. The exchange rate is defined by its “profitability,” i.e. the percentage rate at which it is possible to take out a loan in that currency on the interbank market, which in turn depends on the demand for that currency. A decrease in money supply on the internal market leads to an increase in the demand for currency on the external market — if central bank rates increase, then the exchange rate of the currency increases.
In an ideal situation, currencies with higher percentage rates will grow against currencies with lower percentage rates. However, along with current percentage rates, other factors can influence exchange rates, including expectations of changes in rates according to macroeconomic situations in the country, rumors and the mood of investors. Political factors also play a role, such as speeches by politicians, regional conflict and war.
How are foreign exchange rates connected to inflation?
“Profitability,” or the percentage rate of one currency or another set by the central bank, is determined primarily by the level of inflation in the country. Inflation is the devaluation of money during an increase in demand for goods or services. In other words, if inflation increases, the national currency loses its value relative to goods and services. The central bank, whose responsibilities include maintaining the solvency of the national currency, in the event of extreme growth in inflation increases percentage rates with the aim of reducing money supply. In this case, inflation stops growing, as the value of capital increases, and demand for goods falls (as a result of higher lending rates). In this way, by observing the rate of inflation, it is possible to predict how the key percentage rate will change.
What steps is the Russian government taking to stabilize the ruble?
The ruble is closely watched by the central bank, which regulates its value in respect to other currencies. The central bank uses several methods to change the volume of money in the country, including changing refinancing rates (the rate at which the central bank lends to commercial banks); changing the levels of reserve requirements (the amount of deposited funds that commercial banks have to keep invested in the central bank); and market operations such as buying and selling stocks and securities, currency or other liquid assets with the aim of creating or absorbing liquidity and thereby increasing or decreasing the value of money on the market.
Are speculators a stable influence or do they interfere with economic policy?
Speculators are a separate group of trade participants on the market. They buy and sell assets on a short-term basis, making money as a rule from temporary changes in prices. It could appear that speculators bring confusion and unnecessary volatility to the market, but upon closer inspection, it becomes clear that thanks to speculators, the price for a certain asset on the financial market reflects all the factors that could affect it, and is therefore accurate and reliable. In addition, as a result of the actions of speculators, this is achieved in a very short space of time.
What is the role of hedge funds, insurance companies and pension funds in foreign exchange rates?
Another group of traders on the currency market is long-term investors, who include hedge funds, insurance companies and pension funds. Their main task is to preserve capital, minimize risks and make a little profit, since most of the funds of such companies belong to their clients. Such funds diversify their investment portfolio with different assets, securities and currencies.
What currencies are most heavily traded?
On the global foreign exchange market, almost all existing and convertible currencies can be traded, but not all currencies are of interest for traders. The reason is that some currencies are less liquid than others, and as a result brokers charge a higher commission for buying and selling them.
The news and macroeconomic statistics published daily relate more to the most popular and sought-after currencies, and consequently their listings are more widely predicted than those of less sought-after currencies.
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