Explain why the supply of a foreign currency rises in response to a rise in its exchange rate.
Explain why the supply of a foreign currency rises in response to a rise in its exchange rate.
Rise in exchange rate implies appreciation of foreign currency in relation to domestic currency. It causes a rise in supply of foreign currency owing to the following reasons:
(i) Appreciation of foreign currency induces greater FDI (foreign direct investment) from the rest of the world, because now one unit of the foreign currency converts into more units of the domestic currency. Accordingly, supply of foreign currency increases.
(ii) Appreciation of foreign currency implies depreciation of the domestic currency. It induces greater exports from the domestic economy implying that the supply of foreign currency increases.
(iii) Appreciation of foreign currency induces Fll (foreign institutional investment- investment related to purchase of shares) in the domestic economy, Now purchasing power of the foreign currency rises in the domestic economy. This leads to increase in supply of foreign currency.
(iv) Appreciation of foreign currency increases direct purchases by the non-residents in the domestic economy because of the rise in purchasing power of the foreign currency in the domestic market. This also causes increase in supply of foreign currency.
(v) Appreciation of foreign currency increases remittances from abroad. A unit of foreign currency converts into more units of the domestic currency. Accordingly, supply of foreign currency rises.
Rise in exchange rate implies appreciation of foreign currency in relation to domestic currency. It causes a rise in supply of foreign currency owing to the following reasons:
(i) Appreciation of foreign currency induces greater FDI (foreign direct investment) from the rest of the world, because now one unit of the foreign currency converts into more units of the domestic currency. Accordingly, supply of foreign currency increases.
(ii) Appreciation of foreign currency implies depreciation of the domestic currency. It induces greater exports from the domestic economy implying that the supply of foreign currency increases.
(iii) Appreciation of foreign currency induces Fll (foreign institutional investment- investment related to purchase of shares) in the domestic economy, Now purchasing power of the foreign currency rises in the domestic economy. This leads to increase in supply of foreign currency.
(iv) Appreciation of foreign currency increases direct purchases by the non-residents in the domestic economy because of the rise in purchasing power of the foreign currency in the domestic market. This also causes increase in supply of foreign currency.
(v) Appreciation of foreign currency increases remittances from abroad. A unit of foreign currency converts into more units of the domestic currency. Accordingly, supply of foreign currency rises.
