What is Currency Appreciation?
A currency appreciation is nothing but the rise or enhancement in the value of a national currency over the values of international currencies. This can be as a result of the rise in the demand of a domestic currency in an international market, rise in inflation and interest rates, due to the flexibility of the fiscal policy or government borrowing.
In the below-mentioned diagram when there is an increase in demand for the pound then the value of Pound to dollar increased from 1 Pound = dollar 1.55 to 1 Pound = dollar 1.65.
Impact of Currency Appreciation
#1 – Rise in Export Costs
If the currency of a country appreciates then the number of goods that are exported from that country will drop. This will lower the GDP (gross domestic product) of a country which will ultimately not be in the favour of that country.
#2 – Cheaper Imports
The imported goods shall tend to become cheaper in a foreign country if the domestic goods tend to become expensive on the international market. This means that a domestic currency can be used to buy a higher value of the foreign currency which will ultimately enable the buyers to buy more international goods.
#3 – Results in Trade Deficit
It also results in trade deficitsTrade DeficitsWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory.. This is high because of the fact that strong currencies result in cheaper imports and as a result of this, a nation opts to export less and import more and more.
#4 – Lower Inflation
With an appreciation in domestic currency, the imports will become cheaper and the aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices. will also tend to fall. Therefore, all this together can lower the rate of inflationRate Of InflationThe rate of inflation formula helps understand how much the price of goods and services in an economy has increased in a year. It is calculated by dividing the difference between two Consumer Price Indexes(CPI) by previous CPI and multiplying it by 100. to a significant extent.
Causes of Currency Appreciation
- Lower Inflation Rates- This means that a currency’s value with lower inflation rates will rise in comparison to the value of the currencies with a higher inflation rate. This is generally because of the fact that a lower inflation rate causes a rise in interest rates. Higher interest rates will attract more international investment in an economy and this, in turn, appreciates the demand for domestic currency.
- Investors’ Sentiment- The sentiment of the investors has the tendency to influence the demand and supply for domestic currency in an international market. This is why the sentiments of the investors are considered one of the important causes of appreciation or depreciation of the domestic currency.
- The other causes are government trade, recession, speculation, terms of trade, political stability, nation’s current accounts, etc.
Example of Currency Appreciation
An appreciation in the US Dollar in comparison to Euro-
- During the end of the year 2010 €1 = $1.20
- In the middle of the year 2011 €1 = $1.45
- This means in this period, there was a rise in the value of the Euro in comparison to US Dollar
However, in the year 2014, the value of the Euro fell against the value of the US Dollar.
Difference Between Currency Appreciation and Currency Depreciation
The key difference between currency appreciation and currency depreciation are-
- This can be defined as a rise in the value of the national currency as compared to international currencies whereas currency depreciation can be defined as a fall in the value of the national currency as compared to international currencies.
- It results in cheaper imports whereas currency depreciation results in cheaper exports.
- It results in the rise of imports whereas currency depreciation results in the rise of exports.
- In a currency appreciation, the cost of financing foreign debts with respect to national currency is reduced whereas, in currency depreciation, the cost of financing foreign debts with respect to national currency is not lowered.
- This is more expensive and that is why it can be traded for a higher amount of international currency whereas the same is not applicable in the case of currency depreciation.
- This can be really advantageous as it helps in improving an individual’s standard of living. With an appreciation in the domestic currency, a customer can take advantage of the cheaper imports and make more and more purchasing. With this appreciation, domestic goods might become expensive and this will ultimately cause the imported goods to become cheaper on the foreign market.
- In such a phenomenon, buyers can purchase more of international goods as the domestic currency can be easily taken into use for purchasing a higher value of international currencies.
- This can also be really troublesome for an economy. If there is a rapid appreciation in the currency then it can turn out to be a major problem during economic disturbances. It can also be a reason for the domestic countries to become less competitive in the international markets.
- This can also lead to a rise in export costs. With the appreciation in the currency of an economy, the number of exported goods from that country will fall. This will have a negative impact on the GDP of that country as the same shall fall to a significant extent.
- It may also cause trade deficits as the strong currencies often lead to cheaper imports and as a result of this, a country might want to import more in comparison to exports.
- This is the rise in the value of the domestic currency as compared to a foreign currency. It enables imports to become cheaper and exports to become more expensive. The sentiments of the investors, lower inflation rates, political stability, nations’ current accounts, recession, government trade, terms of trade, speculation, etc are the probable causes of currency appreciation.
- It leads to higher costs of exports, cheaper imports, lower rates of inflation, and so on. These impacts of current appreciation depend upon the ongoing situation of the economy and development in other nations.
This has been a guide to What is Currency Appreciation & its Definition. Here we discuss the impact of currency appreciation and causes along with the example and how it differs from currency depreciation. You can learn more about from the following articles –