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2020 has been a year of fluctuations, especially in terms of currency and cash flow. The year has witnessed massive deprecation in currencies of Asian countries like the Indian rupee, Philippine Peso, and AED. Currency fluctuation is a natural phenomenon that is observed as a result of the floating type exchange rate system which is a prominent system in most of the global economies.
There are various factors that are to be kept in consideration while understanding the concept of currency fluctuations and their impact on economies of the nations. Some of the major factors are supply and demand balance between two economies and their currencies, inflation, the flow of capital along with the difference in the rate of interest.
We all are familiar with the fact that unstable currency fluctuations are not healthy for any economy and can result in instability of capital flow and ex-situ and in-situ trading. Economists and financial experts keep an eye on currency fluctuations to predict its extent and effects on the economy of a nation. Currency is one of those elements of an economy that involves a high level of dependency on various trading sectors, share markets, and forex hence it is crucial to understand the concept.
Before we go ahead and understand the impact of currency fluctuation let us first understand what does it actually means and how is it caused?
We all know that every currency has a value that is calculated against a benchmark currency i.e. USD in most cases. The value of a currency tends to change frequently due to various economic factors and the dynamicity in the value of a currency with respect to another currency is termed as currency fluctuation.
To understand the concept let us consider an exemplary scenario, if the global demand for a particular currency is high due to high levels of foreign investments, or the booming stock market, export business the currency is most likely to sky-rocket its value.
The majority of currencies and their fluctuations are interrelated to each other, there are some currencies that fluctuate freely against each other such as the American Dollar and the Japanese Yen.
The major reason behind the fluctuation of currencies is the floating type of exchange rate system that is prevalent in most of the countries across the globe. The degree of fluctuation and its impact on the nation is dependent on the various economic factors like the relationship between demand and supply for other currencies, the GDP, per capita income, growth of the economies, flow of capital and inflation.
As these factors are highly dynamic in nature and tend to change rapidly, currencies fluctuate in their values as a result. The impact of currency fluctuation is quite far-reaching and includes all sections of society right from consumers to business owners. An important to be kept in consideration here is whether the value of currency appreciates or depreciates the impact will be persistent. If the value has appreciated then, as a result, the currency will respond positively on the other hand if the currency has depreciated then the result would appear negatively.
The most clearly visible impact of currency fluctuation on the level of economy is fluctuations in international trade. Typically, in case of the reduced value of the currency, the exports are stimulated and imports turn out to be expensive. The result of this drift is that the trade of the sector is reduced.
On the other hand, if a currency is strong the exports are reduced and the imports turn out to be cheaper which results in the broadening of the trade shortfall. As a common perception most of us believe that a strong currency is good for the overall growth and sustainability of an economy, the real-time scenario often functions differently.
A very strong currency, in the long run, can result in the creation of a drag since there is no competition amongst industries and thereby a significant amount of jobs is lost. There is a high degree of inter-dependency amongst GDP and exports and if the value of a currency dips sometimes the results are favorable. However, a sudden dip in the value of a currency can trigger inflation as the prices of commodities in the market tend to rise rapidly.
Apart from the impact of currency fluctuations on economic activities, there is a profound impact on economic policies as well. This is mainly due to the fact that the international rate of exchange plays an extremely crucial role in deciding the domestic rates set by the central bank that is followed by the various other banks and financial institutions of the country.
Currency fluctuations impact all sections of the society that includes consumers as well. The first impact of currency fluctuations is that the prices of commodities tend to rise with depreciation. However, if the value of a currency is relatively stable consumers can buy more without paying more for the same commodity. The increased spending and circulation of capital flourishes the economy and benefits all sections of the society.
The prices of oil and petroleum are heavily impacted due to fluctuating currencies. To understand this one needs to understand the relationship between currencies. The US dollar is pegged with currencies of oil-exporting nations like the Saudi Arabian Riyal and the Emirati Dirham. When the US dollar strengthens there is a rise in the value of Riyal and Dirham as they are pegged with each other.
Business is also affected by currency fluctuations. In fact, all types of businesses are affected by fluctuating currencies but the line of business that involves import or export are the ones that are most sternly affected. However, very often businesses that not even involve any sort of import or export are still impacted by fluctuations of currency. This is mainly because there is a dependency on operations which in turn affects the overall revenue and performance.
The prices of life insurance are no different from other categories and are affected by fluctuating values of currencies. The investment market and stock exchange are also affected extensively with the rising-falling value of the currency in the international market.
Multinational companies increase the life insurance prices as a counter to neutralize the impact of fluctuations on their line ups. Life insurance is one of those products that are inevitable in safeguarding and protecting the family. Therefore, the fluctuation of currency and its impact on life insurance prices can cause issues for common people seeking protection against strokes of uncertainties.
In a Nutshell
All in all, depreciating currencies can increase your day to day expenditure on travel, education, healthcare, life insurance prices. To counter the issue of fluctuating currencies the best way is to develop a well-versed and diverse investment portfolio. Diversity in the portfolio provides the negative impacts of depreciating currencies allowing to sustain for comparatively long periods.