Market forces control exchange rate

The value. The foreign exchange rate has an impact on the economic decisions people and companies make.

Whenever there is volatility in prices of goods and services, traders are quick to check out the currency Exchange Rate. The exchange rate which is used in establishing a country’s trade level also mirrors an economy’s health. Bank of Uganda (BoU) director of research, Adam Mugume, explains it in detail.
“The Exchange rate is a price for domestic currency vis-a-vis foreign currency.” Foreign exchange (FX) according to experts, is money denominated in the currency of another nation. The foreign exchange rate is the price of a currency.

The US dollar is considered the as the world’s benchmark or “fixed” currency. This is the number of units of one currency that buys one unit of another currency. Mr James Mutuku, the head of financial markets at Standard Chartered Bank, however, explains that this only applies in markets where the foreign exchange rate is not controlled like in Uganda. “In countries where the exchange rate is controlled, the FX rate will be determined centrally by the government and movement will be confined within a certain pre-determined band,” Mr Mutuku adds.
Each country manages the value of its currency. It may be free-floating, pegged, fixed or a hybrid of the three.

Therefore, a currency pair is a quotation that shows the relative value of one currency against the unit of another currency. For instance, for every dollar traded, one fetches Shs2, 700. A number of theories explain the swings in exchange rates.

Purchasing power parity
Mr Mutuku says this assumes the real exchange rate is the purchasing power of a currency relative to another.

“In addition to the exchange rate being a price, it is also an asset. If you have dollars and the exchange rate depreciates, you get more shillings but if it appreciates, you get few shillings,” Dr Mugume said.
The bet can go either way like any asset. Therefore, negative news or sentiments on a country usually cause depreciation. This also means what foreigners expect to earn on holding a government paper relative to what they can get in another country with similar riskiness can influence exchange rate trend.

Balance of payments
This assumes that the FX rate should be at equilibrium, i.e. the rate which produces a stable current account. It focuses more on tradable goods and services.
Like any commodity, its supply and demand will determine the price if there are no controls.
Dr Mugume said: “When the imports exceed export, the consequence is depreciation. This is the case in Uganda, where imports double the exports,” he says.

This shortfall has traditionally been supported by donor funding which has however declined sharply in the recent past. This has been exhibited in the recent aid cuts by some donor countries.

Aid cuts
“Cutting off aid support to government signals that inflows from donors won’t come which will then put pressure on the local unit,” Mr Faisal Bukenya, the Barclays bank head of money making, explains.
The corruption scandals that have rocked the Office of the Prime Minister this year have already created a ripple effect on foreign aid channeled to Uganda.

In his recent statements, BoU governor Tumusiime Mutebile said because of this situation, the economic growth will feel a 0.07 per cent negative effect.
Other determinants include the uncovered interest rate parity. This assumes that an appreciation or depreciation of one currency against another might be neutralised by a change in the interest rate difference between the two currencies.

The theory on manipulation of exchange rates holds that countries may gain advantage in international trade by artificially manipulating the value of their currencies relative to others, like China versus US.

How to benefit
Mr Bukenya thinks this is a business like any other where people begin with various goals.
“The major problem is speculators and these distort the market which affects the economy,” he says citing a newspaper article that reported about how people lost money through forex trading.”
One can benefit from forex rates by engaging in forex trading using trade platforms through the internet. But one should first understand how it oprerates in addition to self-discipline.

Mr Bukenya says the foreign exchange business is mainly divided into three, i.e. Banks, Forex Bureaus and individual traders. The banks and forex bureaus are regulated by the central bank. But individuals trading online have no official regulation, making them vulnerable to fraud.
It requires technical competence and experience to effectively trade forex. If done well with proper guidance it’s something you can monitor from your home. But like most businesses, it requires some degree of commitment to benefit from it.

dnakaweesi@ug.nationmedia.com