Determinants of currency stability

21 Jun, 2024 - 00:06 0 Views
Determinants of currency stability

eBusiness Weekly

Dr Keen Mhlanga

Currency stability refers to a prolonged period of stable prices and market confidence in the external worth of a currency.

Stable prices are defined by the inflation target, which the Reserve Bank of Zimbabwe aims to achieve through Monetary Policy Committee decisions. Several variables contribute to a currency’s stability.
Here are some important aspects that contribute to the stability of a currency:

Low inflation

Low inflation is one of the most important factors contributing to currency stability. When a currency experiences excessive inflation, its value erodes over time, resulting in a loss of purchasing power.

Central banks try to keep inflation low and consistent in order to keep the currency’s value. Low inflation benefits people by preserving the purchasing value of their money.

If prices rise gradually, consumers can better plan their budgets, increasing spending and investment, which feeds the economy. Lower inflation also promotes corporate growth by providing a stable, predictable environment in which to operate, resulting in additional job possibilities or the opportunity to explore new products and services.

Keeping the inflation low increases Zimbabwe’s competitiveness in the global market and other countries are more likely to invest. This can attract more foreign investment, lead to better trade relationships and strengthen the entire economy.

Global economic conditions

Global economic factors and events can have an impact on currency stability. Trade conflicts, geopolitical crises, and global economic cycles all have the potential to influence currency prices.

Speculation and market sentiment

Market sentiment and speculation both have an impact on currency markets. Investor expectations, risk appetite and market mood can all cause currency prices to fluctuate in the near term.

Economic stability

A stable currency is frequently associated with a steady and expanding economy. Economic stability, defined as low unemployment, consistent economic growth and sustainable debt levels, can assist support a currency’s value.

Economic stability benefits all countries by promoting better monetary policy, lowering business cycle volatility, and encouraging foreign direct investment. Stable economies endure less volatility from economic shocks, resulting in a more predictable and beneficial business environment. This stability is accomplished by methods such as government financial management and the execution of effective FDI-attracting policies.

Furthermore, economic stability promotes an economy’s openness, which increases FDI inflows.

Furthermore, stability is critical in preventing abnormal situations and large-scale power outages in the electrical grid, which has major economic and social benefits. In general, economic stability is critical for long-term growth, attracting investments and maintaining a good business climate for all nations.

Political stability

Political stability is critical to currency stability. Political turbulence, unrest, or uncertainty can cause swings in currency value because investors are hesitant of investing in countries with unstable political environments.

Stability is essential, particularly for developing countries. This is especially vital for countries like ours, where industrialisation, political stability and economic development are still in progress.

Economic progress can be achieved through political stability. Countries experiencing political instability and economic development suffer unfavourable consequences. Political stability can lead to faster and more efficient economic development.

Foreign exchange reserves

Countries with large foreign exchange reserves are better positioned to keep their currencies stable during times of economic instability. Foreign exchange reserves can be used to intervene in currency markets and sustain the value of a currency.

Foreign exchange (FX) reserves support monetary policy by protecting against shocks and ensuring price and financial stability. At the same time, establishing and maintaining FX reserves is not without costs.

To achieve their primary goals, FX reserves should be placed in safe and liquid assets with modest yields.

FX reserves offer significant benefits, including providing a buffer to finance imports or repay debt during times of severe macroeconomic, financial, or political instability. They also provide policy space to maintain price and financial stability in less extreme circumstances.

Market confidence

Investor confidence in a country’s economy and currency is critical to currency stability. Positive economic indicators, effective governance and transparent policies can all contribute to the growth and maintenance of market confidence.

Investor confidence has a significant impact on a company’s performance. It has an impact on capital availability, stock price stability, capital costs and corporate governance and customer and partner relationships. Companies that can efficiently manage investor relations while maintaining high levels of confidence are more likely to prosper and expand.

Balance of trade

A strong trade balance is frequently used to support a stable currency. Countries that export more than they import tend to have stronger currencies since their currency is in greater demand to pay for products and services. A positive balance of trade suggests that a country’s producers have a strong international market. After creating enough goods to fulfil local demand, there is enough demand from outside clients to keep local producers busy.

Sound Monetary Policy

The central bank’s monetary policy is critical to ensuring currency stability. Central banks use interest rates, open market operations and reserve requirements to control the money supply and inflation levels.

One significant advantage of sound monetary policy is that the RBZ will not have to worry about whether price swings are caused by supply or demand shocks. It would solely be concerned with maintaining nominal GDP on the target path.

A second advantage is that it enables the RBZ to indirectly reduce unemployment and inflation.

Unemployment is closely linked to declining real GDP growth. Because nominal GDP growth is equal to inflation plus real GDP growth, maintaining a constant nominal GDP growth rate effectively anchors both prices and unemployment.

A third advantage is that the RBZ may effectively implement nominal GDP level targeting using formulas for determining a central bank’s main interest rate tool. Such restrictions make monetary policy far more predictable and decrease the possibility of the RBZ making a significant mistake.

The RBZ can mitigate the effects of unemployment and inflation by keeping nominal GDP constant. This would result in more macroeconomic stability in the short term.

Lower and more predictable inflation could boost public confidence in the economy’s future and allow them to make better investment and spending decisions. A sound monetary policy is a foundation for a thriving, bountiful economy.

As a whole, economic, political, and monetary factors influence currency stability. Central banks and governments play critical roles in establishing policies that support currency stability and sustain trust in the currency.

Dr Keen Mhlanga is an investment advisor with high skills in finance. He is the executive chairperson of FinKing Financial Advisory. Send your feedback to [email protected], contact him on 0777597526.

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