Foreign Exchange Intervention and Expectation in EMEs - Example

FOREIGN EXCHANGE INTERVENTION AND EXPECTATION IN EMEs By Student's Name Course Code and Name Professor’s Name University Name City, State Date of Submission Introduction Exchanges between various countries of the world have become inevitable. Trade and investments at the international level have allowed expansive distribution of goods and services. Regulation at the international level is characterized by various exchange rates and other economic variables. Obtaining the best level of transactions at international level needs strategized form of exchange rates. Exchange rate is the rate at which various currencies are exchanged with each other. Foreign exchange is an acceptable market practice that resolves the comparative of various currencies. Values of currencies are prone to fluctuations, and it is very rare for them to maintain the same relative value in a given period. Exchange rates are determined in the foreign exchange market where different currencies are traded. Currencies have different buying and selling rates, which are usually dictated upon by the current market forces of demand and supply. Currency is more valuable when its demand is high, and become less valuable when its demand is low. Countries take various initiatives to maintain their currency at an advantageous level so as to achieve more economically. Thus, they usually try to maintain positive foreign exchange rate through policy formulation and regulations. Analyzing the Exchange Rate Problem Exchange rates are useful tools in formulating macroeconomic choices. They are significant in monetary policy where commercial institutions such as the central banks use it as a tool to deal with inflation. Hence, there arises the need for intervention to steer exchange rate and perform the expected functions. This will limit shortcomings related to incompatibility in exchange rate. Emerging Market Economies are entirely affected by exchange rates. Exchange rates are a type of macroeconomic theory that is of great concern to these economies. This is because inflation, which is as a result of external shocks, is usually imposed on their economy and affects exchange rate (Bořek 2010). EMEs usually have huge capital inflow and therefore calling for great intervention. The question we should ask ourselves is; do these interventions have any effects? Central bank offer and guides various interventions in foreign exchange markets. Central bank plays a crucial role where it helps participants to know the ideal exchange rates. A study from Japan showed that currency purchases by central bank led to adjusted forecasts of its currency and exchange rate. Interventions help to forecast and increase certainty in economic level of any emerging market. These forecasts allow evaluation of the effects of intervention. Interventions are recommended to regulate exchange rate prospects. Exchange rates are determined by a number of factors. These determinants are interest rate differentials, credit risk and perceived country risk. Interest rate of differentials outlines that, high domestic interest of any developed nation usually weakens the exchange rates in EMEs. These economies are weakened by high exchange rates since there is disparity on economic levels. Emerging Market Economies experience high level of risks which usually translates to currency depreciation. Consequently, the domestic economy of EMEs deteriorates hence inequality in exchange rates. However, an augmented model has been developed. This recounts that, even though interests’ rates of more developed economies are higher than those of EMEs, exchange rates of EMEs can rise as a result of risk premium change. The augmented model expectation is that risk premium or future interest rates can affect exchange rates although it does not affect domestic interest rate (Bořek 2010). Effects of central bank intervention have as well been formulated through regression model. This has depicted change in movements of exchange rate. This model primarily concerns with formulating statistical significance of other variables affecting exchange rate and the direction expected. EMEs have different floating exchange rates. Asia and Latin America have been reported to be more vigorous as a result of increased foreign capital inflows. Other countries with different capital inflows have also been considered. They have different approaches when it comes to cope with the impact of capital inflows. To understand rate of exchange of various EMEs, a three-month exchange rate forecast has been undertaken. This survey however showed certain shortcomings as it did not necessarily reflect the expectations. There is high disparity in their economic level since they have different amount of resources at their disposal. Additional key variables that affect exchange rate of EMEs are externally formulated. EMEs are affected by international prices, for example, international energy prices. These high prices translate to inflation and consequently unfavorable exchange rates. Capital inflows have as well been regarded to affect exchange rates. Global financial crisis have made the developed economies, and especially investors to reallocate their funds on favorable EMEs macroeconomic performance (Bořek 2010). This has prompted the EMEs to alter their exchange rates. Moreover, foreign bonds also affect exchange rates. Interpretations of the foregoing study show that interventions do not change the exchange rate expectations. It argues that the exchange rate expectations are unchanged and concludes that exchange rate movements in the spot markets would delay expected values of appreciation. The study also interprets that banks can draw more foreign inflows hence leading to favorable emerging market exchange rate. Finally, it proposes that an increase in exchange rate can strengthen investor’s exchange rate anticipation and capital inflows. The study concludes that intervention can increase exchange rates and exchange rate forecasts. The intended purpose is rather to counterattack negative effects of the exchange rate fluctuations but in many instances, this is not achieved. Currencies of the EMEs are affected by these exchange rates irrespective of their initiatives to fight their implications on their economies. Interventions in exchange rate of EMEs cannot be guaranteed primarily by the central bank. The analysis formulated has only compared a relatively portion of time periods to try and verify the role of central bank to stabilize the exchange rate. Time dependent study showed that the exchange rate deviates every now and then. The strategy should however incorporate a long-term analysis in order to arrive at a critical condition that could substantiate whether interventions by central banks are viable (Bořek 2010). Market rates fluctuate and it is not easy to formulate a dependable conclusion. Economies vary between different countries. Monetary policies of these economies are, thereby, different as they have diverse frameworks with regard to exchange rates. EMEs cannot be equated with more developed economies. Frameworks that have been applied by various economies should not be imposed to them. There are various dynamics between these economies and detailed analysis as well as new mechanisms of interventions should be applied. Economic models have been applied to explain interventions of exchange rate. This methodology should at least contain comprehensive data analysis for it to come up with a desired conclusion. The models constructed should incorporate all the relevant variables that would influence foreign exchange rate. However, to formulate a desirable theory or model, there is need for a comprehensive data analysis since exchange market is affected by various variables such as interest rates and price of exports and imports. Foreign exchange rate interventions are not an independent policy tool hence requires great measures to be formulated. EMEs can deal with exchange rate caused by international fluctuating prices. This will reduce implications caused by foreign exchange market. This in return is not attainable at a glance since EMEs lack the resources required to deal with effects of inflation. This form of transferable inflation inhibits proper foreign market exchange to EMEs and they are unable to have favorable exchange rates. EMEs have to formulate policies that would enable them to limit this effect. The main challenge to this issue is that, prices of goods and services from abroad are relatively low, hence generating high level of competition to the locally available goods and services (Bořek 2010). As a result, more will be imported than exported and this means that exchange level of EMEs will be low. EMEs are subject to various uncertainties. Interventions by central banks are affected by the daily economic uncertainties due to a number of sociological and economic factors. These economies are usually affected by political unrests and climatic changes. Political instability affects the economy resulting to increased inflation. This affects exchange rate as the economy’s currency is exchanged with more of foreign currency due to increased dependence on imported goods. Climate of EMEs tend to change every now and then. EMEs’ economies are primarily agricultural-based, and they rely on rainfall and other favorable climatic conditions of which tend to change from time to time. EMEs are prone to economic depressions. This, however, affects all partners of international markets, but EMEs are the most affected (Bořek 2010). When foreign market is affected by economic depressions, exchange rates are also affected since transactions must be carried out. Huge debts affect EMEs and this makes their economic performance to grow at a very slow rate. Debts usually decrease the exchange rate level since they have to repay for what they owe their trading partners. This has largely affected foreign markets of EMEs leading to unfavorable exchange rate. Conclusion It is certain that foreign exchange rate cannot be neglected in economic operations. EMEs, therefore, need to formulate policies that would enhance stability. Favorable exchange rate ensures that EMEs can achieve much since more will be obtained from international market. A fixed exchange rate structure will tend to eliminate volatility and fluctuations. EMEs should have a fixed exchange rate in order to provide a constructive money market of its economy so as to minimize price fluctuation levels that they experience. These economies need to have a favorable balance of payment. They must endeavor to export more than they import. When exports are more than imports, income from international trade will increase. The exchange rates of EMEs become favorable as a result of increased exports. Their currencies also become strong against those of their trading partners. Investments should also be increased in EMEs. Local investments should be encouraged by the government through incentives and subsidies. References List Bořek Vašíček. (2010). Monetary Policy Rules and Inflation Processes in Open Emerging Economies. Eastern European Economics, Asia and Africa. Read More