What is the importance of Foreign Exchange?

importance of Foreign Exchange

One of the prime contributors to Globalisation is foreign exchange. Commonly known as Forex. In Forex, a country’s currency is weighed against another country’s currency and the value is determined. Like for example, in order to know the value of rupee, you compare it with say, Japanese Yen. JPY to INR conversion would give you an idea of how well Indian economy is doing, when compared with Japanese economy.

This value is determined by market conditions, trades, investments, tourism, political risks, and policies, etc.

Background info on Forex

Before we get to understand its importance, let us understand Forex a little better.

The Forex market trades currencies. To state some facts, currency trading exceeds $5 trillion a day. This makes it the most liquid and the biggest financial markets across the globe. Great Britain has the largest share in the Forex market. This is because around 40% of all transactions occur in London. The strong infrastructure, which is in place for currency trading, contributed to the expansion of Forex. And just like that, Britain managed to change the face of civilisation, yet again.

Getting to the importance of Forex market:

  • Backbone of global trade

Considering how things now have the potential to go global, forex market has become vitally important. With transactions taking place all over the world now, people no longer face the barrier of currency conversion.

  • Smoother import and export

Without Forex, import and export industries would not have flourished the way they have. Without sound import and export policies in place, courtesy Forex market, we countries would not have a mean to develop. Progress would be stunted. Who knows, we would still be bartering things?

  • Industrial growth

Import and export is regulated by companies, both private and governmental. If there was no medium available that allowed trading in different currencies, economy of each nation would be at a standstill and nothing would prosper. Companies would make negligible profits, thereby consequently perishing.

  • Investments

A considerable amount that flows through the Forex market is investor’s money. Investors use forex like JPY to INR to diversify internationally. Diversification brings certain benefits to investors, and that would not have happened without Forex. International trade and transaction is now possible only because we have the ability to exchange currencies. Investors trade currencies in order to buy or sell foreign assets, securities, etc.

  • Functions:

Forex is important to international economy because of the functions it performs.

The key functions it follows are:

  • Transfer:

Being the basic of functions of Forex, it facilitates the conversion of one currency to another. This aids accomplishment of trades between countries and aids in the fulfilment of the above-mentioned importance of Forex.

  • Credit:

Forex provides credit, both nationally and internationally. This is done to promote foreign trade. When foreign bills are used in an international payment, there is a credit for around three months, which is required.

  • Hedging:

Hedging is the avoidance of foreign exchange risk. It sets up contracts, normally for three months, to buy or sell foreign exchange against another currency at a fixed rate.

Owing to all the functions carried out by Forex, the world has come together better than before. Globalisation has kicked in due to the unhindered exchange of currencies. This ensures progress now, and in the years to come.

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