Which is better: a “high” or “low” exchange rate?
Maybe you’ve heard the words “high” and “low” used to describe exchange rates, probably in the context of one being better than the other.
In reality, neither is inherently better than the other. When you prefer a high exchange rate versus a low one, or vice versa, depends on how you plan to use a specific currency.
When it comes to sending money internationally, a high exchange rate is preferable. Why? Because it means your money is equal to more units of another currency. In fact, a currency that benefits from a high exchange rate is often labeled as “strong.”
To illustrate the difference between high and low rates, take a look at these two hypothetical exchange rates for the U.S. dollar to the Indian rupee.
In the first example, one U.S. dollar is equal to 76.970 Indian rupees. That’s a high exchange rate compared to the second rate, in which one U.S. dollar is equal to 71.671 Indian rupees.
The second exchange rate is considered low because the U.S. dollar cannot buy as many Indian rupees—about five less than the first rate.
A low exchange rate isn’t desirable when sending money abroad because your recipient is getting less than they otherwise might have received with a higher rate.
For this reason, a low exchange rate is preferable when you’re selling currency.
How often do exchange rates change?
With bankers and traders buying and selling currencies 24/7 in the foreign exchange market, exchange rates are always changing—not just once per day, but multiple times.
Because of this, the value of a currency never stands still.
How is an exchange rate determined?
Put simply, the value of a currency and its exchange rates are determined based on how desirable it is to hold that specific currency.
There is no single telltale sign that influences this perception of desirability but rather, several factors that reflect a country’s economic health. These include a country’s:
Balance of trade
Political and economic stability
An interest rate is the amount a lender charges for borrowing money, usually written as a percentage.
Interest rate is strongly connected to foreign exchange rates and inflation, so much so that central banks influence exchange rates by manipulating their interest rates.
A higher interest rate generally increases a currency’s exchange rate because it attracts foreign investors, meaning greater returns for anyone lending money.
The opposite happens for low interest rates: when an interest rate decreases, so does the exchange rate. However, inflation plays a role in that if a country has a high inflation rate, a high interest rate has little effect on a currency’s value.
In other words, interest rate alone isn’t enough to increase a currency’s value and exchange rate.
Political and Economic Stability
Both politics and the economy can affect a country’s exchange rates. Major events may cause uncertainty for foreign investors, and in turn, negatively influence their behavior.
That’s because investors want to feel confident about a country, and political or economic unrest signify risk.
But if a country shows signs of economic growth and stability, it will remain an attractive investment opportunity. More investors will seek out its goods and services, driving up the demand for its currency and as a result, increasing its exchange rates.
The size of a country’s debt can also influence its currency’s value and exchange rate. A large debt may discourage foreign investors who, concerned that a government may default on its debt, would prefer to invest elsewhere.
Additionally, because a large debt affects a currency’s value, it can also indirectly lead to inflation. As a result, the exchange rate will lower.
Less debt, on the other hand, can make a country more attractive to investors, especially when combined with promising economic growth.
This will lead to an increased demand for its currency, and thus, a higher exchange rate.
Why do exchange rates matter when sending money abroad?
Simply put, when you’re sending money abroad, you want as much money as possible to make it to the destination country.
A low exchange rate means that your money converts into fewer units of another country’s currency—and as a result, your recipient receives less money than if you had transferred your money at a high exchange rate.
Unfortunately, getting the best exchange rate for an international money transfer isn’t so straightforward.
What does this mean for your money? Even a small difference in exchange rate could mean losing hundreds of dollars to the bank or transfer company.
Whatever your needs are, Agathis is your specialist partner is cross border payments. Contact us today and together we’ll come up with the best and most cost-effective plan for your business!