In the today’s economically integrating world, political borders are not so effective to control the flow of capital when the countries are fully convertible on current account. When the world is single marketplace, the importance of currency market and need for convertibility is growing never before. Let’s learn the currency market and convertibility in detail.
What does currency mean?
Currency is a medium of exchange for goods and services. It is system of money in the form of coins and notes and accepted at its face value.
Officially, it is issued by the governments and not any agencies. US dollar, Euro Australian dollar, etc.are the examples of currencies.
First of all, let’s know the types of currencies — soft and hard currencies. It is indispensable to uncover currency market and convertibility.
Hard currency Vs soft currency
Hard currency is currency that is more reliable, less volatile and highly accepted as a medium of exchange in the international transactions.
On the other hand, soft currency is the currency that fails to hold its value and highly vulnerable for the sudden political and economic changes happening in the respective country.
Examples and characteristics of hard currency
There are certain characteristics of hard currency.
- First, hard currency is less volatile and sensitive to political and economic changes happening in the country.
- Second, hard currency doesn’t loose its value in any condition, so, it is widely accepted in the international transactions.
- Third, investors across the world always prefer to invest in the hard currency in case of global crisis and sudden challenges etc.
- Fourth, developed nations can only have hard currency as theirs economies are more stable and less react to the economic and political changes.
US dollar, Euro, Australian dollar, Canadian dollar, etc. are considered as the hard currencies. And, most importantly, all the currencies belong to the developed nations in the world.
Soft currency — meaning, characteristics and examples
Soft currency is the currency that is vulnerable to the political and economic changes, and reacts to such changes. Here are some characteristics of soft currency.
First, soft currency always reacts as like appreciates and depreciates to the unexpected political and economic changes in the country and world.
If there is political stability and economic growth, currency tends to appreciate and investors invest hoping to gain more value. Whereas, in case of political and economic instability, currency looses its value forcing investors to take flight.
Second, soft currency is not so stable to act as medium of exchange in the international transactions due to changing exchange rates.
Third, being so sensitive to the happening, soft currencies may face currency crisis in case of negative impacts. For example, the (Turkish lira)
that was depreciated due to political instability.
Advantages of hard currency and soft currency
As I mentioned before that hard currency doesn’t loose its value even there is instability. Hence, investors always prefer to invest capital in such currency.
The nations having hard currencies, have better chances of getting capital and funds compare to having soft currencies.
Usually, countries depend on import, better to have hard currency as it hardly depreciates. Whereas, export driven economy deliberately depreciates currency to make its goods more competitive.
Undoubtedly, hard currency is always used as a medium of exchange in the international transactions and its value remains unchanged. Hard currency belongs to more stable and developed nations, whereas, so currency belongs to developing as well as underdeveloped nations.
Examples of hard currency and soft currency
Following currencies are well known examples of hard currencies.
- US dollar
- European Union (the Euro)
- Canada (the Canadian dollar)
- Switzerland (the Swiss franc)
- Australia (the Australian dollar)
- Japan (the Japanese yen)
- Britain (the British pound sterling)
Soft currencies examples
Currencies belong to developing as well as underdeveloped nations have soft currencies due to political and economic instability. Here are the examples of soft currencies.
- The Turkish lira
- The Iranian rial
- The Vietnamese dong
- The Indonesian rupiah
- The Venezuelan bolivar
- Syria (the Syrian pound)
- China (the Chinese yuan)
- India (the Indian rupee)
Last thought on hard and soft currencies
Actually, no currency of a nation has ever be hard or soft. But, it depends on the level of economic development and political stability over the period of time.
In the time of pandemic COVID-19, almost all the currencies in the world depreciated unexpectedly against the US dollar. Later, dollar weakened due to liberal monetary policy by central bank. Now, it is peaking once again in order to control growing inflation in US.
Hereon, I’m going to explain the currency market and convertibility in detail.
What does currency market mean?
An arrangement in which market participants buy and sell different currencies they wish is called currency market or forex market.
In reality, there is nothing like a physical place but a web of online platforms operating from different locations and countries.
Nowadays, almost all the nations having trade relations with outside world are fully convertible on current account to facilitate trade activities.
Accordingly, traders, corporates, banks, firms, brokers, and dealers participate in the currency market to get desired currency to make trade, deals, to study abroad, and for tourism purposes.
Nature of currency market or foreign exchange market
Currency exchange market is non-stop as it depends on different time zones beginning with Japan, east Asian Japan, followed by India, Europe and American markets.
Simply put, international currency market is 24 hours market barring Saturday, Sunday, and other holidays.
Technically, trades trade currencies in pairs like USD/EURO, US/GBP, USD/INR etc. Buyers buy currency contracts and sellers sell. People also exchange theirs domestic currency with dollar to make payments outside world through foreign exchange banks or intermediaries.
Foreign exchange or Currency market participants
Banks, dealers, big firms participate in the currency exchange market. Some act as intermediaries, some as investors and others may be as speculators.
Speculators across the world buys and sells currency they wish hoping either to increase or decrease currency exchange value in future.
Besides, traders need foreign exchange to make payments outside of the nation. And, corporates hedge the risk of the deal fearing the fluctuations and the currency exchange.
Students, tourists, and patients swaps their currency to get USD to study, tour, and take treatment outside.
Currency market and convertibility– capital account convertibility and current account convertibility
There are two types of currency convertibilities. One is current account currency convertibility. And, second is capital account convertibility.
Capital account currency convertibility
Investor having freedom to conduct financial transactions outside of the country to purchase financial assets like stocks bonds and debentures, are called capital account currency convertibility.
If a person wants to make payments for purchases of goods and services outside of country and there is no restrictions to convert domestic currency with dollar to do so is termed as current account currency convertibility.
Understanding capital account currency convertibility
Capital account currency convertibility mean no restrictions on the amount of rupees you can convert into foreign currency to enable you, an Indian resident, to acquire any foreign asset — The Hindu business line.
Capital account is a part of balance of payments in which capital inflow and outflow is recorded. If the money is invested outside country to purchase financial assets is called outflow and debit to the capital account in source country.
But, if the money is invested in your country to purchase financial assets, is termed as capital inflow and it is credit to the capital account of received nation.
Actually, debitor to the capital account means it is going to receive investment income on the current account. And, creditor to the capital account means it is liabilities on the nation received.
Fully or partial capital account convertible
Not all nations like current account, capital account fully convertible. Generally, developing countries are much causious about the capital account because of possible currency exchange volatility.
Likewise, developing countries like India is partially convertible on the capital account even though they started liberating capital account three decades ago.
Contrarily, almost all the developed nations are fully convertible on the capital account. Owing to theirs economies are more resilient for the shocks arising out of currency volatility.
Capital account convertibility pros and cons
Usually, it is widely advocated to open the economies for the economic integration and cooperation. But, unlike current account, capital account is not that much of safe but prone to overvaluation of the currency in the forex market.
If a country choose for capital account convertibility, there are chances of inflow and outflow of capital in the short period of time. In case of opportunities and political and economic instability both impacts may be possible. There is possibilities like depreciation and appreciation of currency.
In case of over appreciation, the exported goods and services may be hammered by competitors due to overvaluation. On the other side, current account deficit may get widened if the value of currency gets over depreciated.
Last thought on capital account convertibility
Capital account convertibility is the need of hour.It is essential to boost global economic co-operation and integration. But, at the same time, developing countries should be causious. Because of theirs economies are not fully resilient to absorb shocks of overvaluation of currencies due to unexpected volatility.
For developed nations, there is nothing to worry to go for fully convertible on capital account. As they are well prepared to capture arising economic opportunities in the resource rich world. This is all about the capital account convertibility.
Current account currency convertibility
Current account currency convertibility is essential to make payments outside of the nation for purchases of goods and services. It is all about the purchasing goods and services they wish and make payments without barriers or regulations.
Current account and capital account are the two accounts of balance of payments. As I explained before that balance of payments is a summary of economic transactions one nation does with rest of the world.
Current account is all about the exports and imports in goods and services alone investment income and current transfers. Whereas, capital account deals with the capital flow with the outside world in the form of purchasing financial assets like stocks, bonds, etc.
Understanding current account convertibility
Literally, current account convertibility is indispensable to ensure smooth functioning of exports and imports with the outside world.
Suppose, you want to purchase a thing that is not available in your country and you have to make payment in dollar if you purchase from outside of the nation. What do you do? Simply, you will exchange or swap your domestic currency with the currency your dealer accept. But, only on condition that your government permits to do so.
A process by which a person can convert or exchange its domestic currency with any other currency he or she wish to do without any barriers or interventions by government is termed as current account convertibility.
Current account convertibility refers to the freedom to convert your rupees into other internationally accepted currencies and vice versa without any restrictions whenever you make payments — The Hindu business line.
Advantages of current account convertibility
Briefly, if a trader wants to convert domestic currency to USD on the current account or make payments for purchases outside world, no one could stop him to doing so. Because, the country has permitted fully current account currency convertibility.
Undoubtedly, to boost trade relationships, promote international trade, global economic co-operation and ensure greater economic growth and development, current account currency convertibility is unavoidable.
Present state of currency market and convertibility on current and capital account
At the present, most of the developing countries are fully convertible but in terms of capital account convertibility, there is hesitation and apprehensions.
Capital account currency convertibility is the major characteristic feature of the developed nations. These nations are fully convertible on the capital account as well.
Today, most of the nations have fully permitted current account currency convertibility to empower trade ties with partners.
India after 1993 LPG (liberalization, privatization, and globalization) policy, permitted fully current account convertibility to boost trade relationship.
Importance of currency market
Global Currency Trading Surges to $7.5 Trillion a Day, BIS Says April daily volume climbs 14% from 2019, survey shows that Dealers trade more as swings create ‘inventory imbalances’ — Bloomberg news.
It shows how the currency exchange market is rising rapidly as more and more nations are permitting to convert domestic currency or becoming more convertible on capital account.
Generally, developing countries are more reluctant to be fully convertible on capital account owing to higher volatility or fluctuations in currency exchange rates. But, developed economies are more stable and resilient to ongoing fluctuations.
After all, smooth exchanges of currencies across the world is utmost important as to boost global trade and buy and sell of financial assets.
Solved Questions on currency market and convertibility
For thoroughly understanding of currency market and convertibility, following solved questions would definitely help you.
Q. 1. What is mean by currency market?
Ans: Currency market isn’t a physical place but an arrangement worldwide in which market participants buy and sell different currencies.
Presently, almost all the sovereign nations have trade relations with outside world. Hence, it is indispensable to have foreign currencies to settle trade deals.
Participants like, traders, corporates, banks, firms, brokers, and dealers participate in the currency market to get desired currency to make trade, deals, to study abroad, and for tourism purposes.
Q. 2. What is the difference between hard currency and soft currency?
Ans: Compare to soft currency, hard currency is more reliable, less volatile and highly accepted as a medium of exchange in world market.
On the other hand, soft currency fails to hold its value and highly vulnerable for the sudden political and economic changes.
Generally, nations having hard currencies, have better chances of getting capital and funds compare to having soft currencies.
Q. 3. What are the examples of soft and hard currencies?
US dollar, Euro, Canadian dollar, Swiss franc, Australian dollar, Japanese yen, British pound sterling are the examples of hard currencies.
lira, rial, Vietnamese dong, Indonesian rupiah, Venezuelan bolivar, Syrian pound, Chinese yuan, Indian rupee are examples of soft currencies
Q. 4. What does current account currency convertibility mean?
Ans: To make payments outside of the nation for purchases of goods and services, people need foreign currency.
So, it is permissible to convert as much as the person wants to make payments for foreign goods and services.
In short, it is all about the purchasing goods and services they wish and make payments in foreign currency without barriers or regulations.
Q. 5 what do you know by capital account currency convertibility?
Ans: Capital account currency convertibility mean no restrictions on the amount of rupees you can convert into foreign currency to enable you, an Indian resident, to acquire any foreign asset — The Hindu business line.
In simple terms, person can convert any amount in foreign currency to purchase financial assets like stocks bonds and debentures outside world.
It may result in the fluctuation of exchange rates, currency crisis if it is prone to the political and economic changes happening in the given country.
This is all about the currency market and convertibility on current account as well as capital account.
Understanding Hard and soft power
Explaining Balance of payments