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Meaning of the exchange rate and the implications of changing it
Books / Salah Hizam
The exchange rate means the reciprocal relationship between the national currency and the rest of the world's currencies.
And this is either directly or through an intermediate currency (the relationship of the Iraqi dinar to the currency of Vietnam or Paraguay, for example, is done through the relationship of each of these currencies to a third currency, such as the US dollar, for example). The prices calculated in this way are called cross rates.
There is an exchange rate for sale and an exchange rate for purchase. That is, there is a price when an individual or company asks for a number of foreign currency units, and this is called the selling price.
There is another price, which is usually lower, and it is called the purchase price. It is meant when an individual or company owns units of a foreign currency and wishes to exchange them for the national currency.
In other words, it is the number of units of a particular foreign currency that can be obtained against one unit of the national currency. Or, it can be said in reverse, as it is said to mean the number of units of the national currency needed to obtain a unit of a particular foreign currency.
Thus, trade relations in all its forms between countries are determined on the basis of this transfer price. This is the factor that determines the attractiveness of a particular country's goods in the markets of another country or vice versa, as it may appear cheap or expensive
From the users' point of view of that commodity.
And currencies are types, including a local currency that cannot be traded outside the borders of the countries that own that currency (according to the law).
And currencies are negotiable in the global market (hard currencies) foreign exchange
Like the dollar, the euro, the pound, and the yen ...
And the currency of a foreign country is not only needed by companies when imported from that country only, but also by those who travel to that country.
This is what makes some countries work to reduce their exchange rates to encourage exports to other countries as well as reduce imports, because imported goods will be of high prices and people will be reluctant to buy them.
The exchange rate and its changes are of great importance in adjusting the state’s balance of payments conditions, whether it is developed or developing countries. Whereas, lowering the exchange rate, for example, reduces imports and increases exports, which will positively affect the status of the balance of payments. The opposite happens when the exchange rate is raised.
This is a major reason for the United States' continued pressure on China to raise the exchange rate of its currency (the yuan), because this will reduce the degree of competitiveness of Chinese products in the US market, as their prices will rise when converted to US dollars.
How is the exchange rate determined?
There is a fixed exchange rate set by the authorities against a single currency (strong and stable, such as the dollar) or against a basket of currencies that includes the currencies of the main trading partners.
There is a flexible or floating exchange rate (an administered float that is driven by the authorities according to the requirements of the economic situation or a flexible float determined by market forces and economic conditions).
Effects of changing the exchange rate:
When the exchange rate changes, the prices of imported goods change (rise lower and lower at high). Likewise, prices of locally produced goods change if they depend on imported parts or raw materials. The change in the exchange rate also affects the performance of investments, the interest rate and the rate of inflation.
The effect of that change may extend to jobs and the real estate sector.
The most prominent of which is changing the population’s standard of living for better or worse. This may raise the rates of poverty and deprivation among certain segments of the population (when the exchange rate falls).
The effect is more evident as the number of imported products increases (such as Iraq, for example), and it increases by the devaluation of the currency (at least) in addition to the possibility of higher prices more than that as a result of merchants' exploitation of the price chaos that the decision generates as a result of the greedy desire for more profit, or from a door Hedge the worst, especially in the absence or lack of confidence in the authorities that control the exchange rate.
Why is the exchange rate changed?
The most prominent reason is to subsidize exports and reduce the demand for imported materials. This leads to an improvement in the balance of payments situation and an increase in the foreign currency reserves in the country.
The reasons may also be purely developmental and not related to the status of the balance of payments, as the decision leads to an increase in the demand for local products and thus increased production and employment, etc. ... (assuming the availability of capacity and the desire to increase local production).
In a rentier country like Iraq, in which the government’s budget depends on its revenues from exporting oil, this decision raises the proceeds in Iraqi dinars, which the Ministry of Finance obtains from selling dollars to the Central Bank and according to the rate of reduction in the exchange rate (the finance used to take from the central bank 1,200 dinars for each A dollar, now she takes 1,450 dinars for every dollar.)
Oil export revenues belong to the Ministry of Finance, which it sells to the Central Bank, which keeps dollars there for use in fulfilling import obligations and the like.
Countries whose currencies are fully floating (free float) cannot make a decision to raise or lower the exchange rate directly, but rather use indirect tools to achieve this, including changing the interest rate (which is carried out by the Central Bank).
In conclusion, changing the exchange rate confuses companies' accounts, confuses contractual relations, confuses relations between wholesalers and retailers, causes serious chaos in the relationship between creditors and debtors, and renders companies' financial statements meaningless, as well as companies' business results and final accounts.
I will address on a future occasion the issue of economic and financial accounts in light of inflation caused by the sudden and large reduction of the national currency exchange rate, God willing.
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