The currency exchange rate is the rate that determines how much you need to pay to buy another country’s currency. For example, at the time of writing this article, 1 Euro (EUR) can be bought for 78.5563 Indian Rupee (INR).
You probably need to do this exchange whenever you are travelling to another country. You should, in fact, be very aware of this exchange rate fundamentals if you are trying to export your goods and services across borders.
How are currency exchange rate fixed between two countries?
From what I’ve learnt and known, it largely depends upon the demand of a particular currency. Besides this, there are macroeconomic factors that define the economy of a country namely the rate of unemployment, inflation, gross domestic products so and so forth.
I am sure you are aware of what’s happening in Venezuela with inflation as its all over the news for quite a while. We’ll briefly talk later about.
SO, what determines the exchange rate?
1. Inflation
If the availability of paper money is higher than the demand for goods and services, that lowers the value of a currency. Furthermore, if the availability is extremely high, that leads to an increase in the inflation rate.
2. Government Debt
The more a country owes the debt to another country, less likely it is to acquire foreign capital. This, in turn, leads to inflation. Normally developing countries exchange rate is low because of his reason.
3. National Commodity
Let’s consider an example of Australia, the country that is one of the leaders in gold exports and the AUD exchange rate is positively correlated with the gold price. Every time the gold price goes up, Australia benefits the most. That is because its currency appreciates proportionately with the increase of gold.
Same is the case of major oil exporting countries when oil prices go up.
Other main reasons that make the exchange rate fluctuate is the Trade Policies, Recession and Political Stability of a particular country.
What happened in Venezuela?
Much of the blame for the turmoil caused in Venezuela go to Hugo Chavez, the former president of the country who ruled from 1999 to 2013. However, Nicholas Maduro, his successor also continued the legacy of financial mismanagement.
Chavez, during his presidential term, introduced the different social program with an aim to increase the living standard of people. Considering the oil reserve would help to pay back, Venezuela was more dependent on foreign debt to run these programs. Chavez was, in fact, successful in reducing poverty and increasing living standard as he had anticipated. Therefore he was carried away by his momentary success and popularity that he gained.
In 2012 public spending went so high that it went past the national GDP taking the country’s debt to more than 106 Billion USD.
The drop in oil prices in 2014 dented the situation further for the country. Despite having the largest oil reserve in the world, Venezuela was unable to handle the debt. After Chavez’s death, Nicolas Maduro’s decided to print as much money to negate the oil price drop effect. This has lead to the current hyperinflation.
There is a lot of money with the public thus inflation is so high that in 2018 a cup of coffee was worth 2.5 Billion Venezuela’s currency (Bolivars). This situation is also subjected to incompetent government policies, immature financial planning and deeprooted bureaucratic corruption.
