INTRODUCTION:
1) The rate of exchange of a currency is its price in terms of another currency, or a group of other currencies.
2) The foreigner exchange market is a place where the foreigner currencies are bought and sold.
3) The rate of exchange of a currency is said to be in equilibrium if there is no excess supply, of or demand for it in the foreign exchange market, and therefore there is no tendency for the exchange rate to change.
4) It is the rate at which the demand for a foreign currency is equal to its supply at a given point of time.
5) The concept of equilibrium rate of exchange is relevant only when market forces are allowed to operate freely in the foreign exchange market.
6) The equilibrium exchange rate, expressed as the value of a foreign currency in terms of the domestic currency, is determined by the demand for and supply of the foreign currency.
DEMAND FOR FOREIGN EXCHANGE:
1) Import of goods: Most countries import goods to meet domestic demand and to take advantage of cost differences with other countries. Countries trade in capital, intermediate and consumer goods. The price of imports and the demand for foreign exchange are inversely related.
2) Import of services: Services import of many countries has increased manifolds after the creation of the WTO and the development of communication technology. In the case of services also there has been an increase in demand. Payment for services like banking, insurance, transport and communication, and other services require foreign exchange.
3) Unilateral payment: These are payments from one country to another that do not correspond to the purchase of any good, service or asset. These include donations, gifts, repatriations (returning of income like profits, dividends, interest to investing and creditor countries), remittances sent by foreign workers working in the reporting country, foreign aid and assistance given by the government of a country to other countries.
4) Export of capital: Capital leaves a country in various forms, resulting in demand for foreign exchange. Repayment of debts, purchase of assets by residents and government in foreign countries, investments in financial assets in foreign countries, foreign direct investments and lending to foreign nationals, all generate demand for foreign exchange.
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