Factors Affecting Exchange Rate

I. Balance of payments: Balance of payments is one of the important factors influencing the exchange rate. For instance, if the balance of payments of a country is a surplus, the demand for the currency of that country in the exchange market will be higher than its supply.
II. Inflation: Inflation is another factor that influences the exchange rate, with inflation in a country; the prices of the products produced in a country will not be competitive in the world market. As a result, the exports from that country would decline.
III. Interest Rates: Interests rates are one of the factors influencing the exchange rate. Increase in interest rates in a country attracts short term funds from abroad and results in increase in the demand for the currency of that country.
IV. Money Supply: Money supply also influences the exchange rate. Increase in money supply in a country causes inflation in that country, and this would lead to decline in the value of the currency of that country.
V. National Income: National income is one of the factors influencing the exchange rate. Increase in national income of a country will result in higher demand for goods and higher production. Higher production may lead to higher exports from that country.
VI. Movement of Capital: Movement of capital also influences the exchange rate. Better investment climate may encourage movement of capital to that country from abroad. Inflow of foreign capital will result in higher demand for the currency of that country.
VII. Political Stability: Political stability also influences the exchange rate. Political stability in a country infuses confidence in the investors. As a result, there will be capital inflow into that country.