What Is Currency Appreciation?

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The value of any country’s currency is measured in relative terms to that of other foreign currencies. By definition currency appreciation occurs when the value of a country’s currency increases with respect to a foreign currency. This article delves into everything you need to know about currency appreciation.

Understanding Currency Appreciation

The primary causes that result in currency appreciation are:

  1. Lower Inflation Rates – Lower inflation rates may cause a currency’s value to increase. It occurs because lower inflation commonly attracts higher interest rates, which attracts more international investment, thereby increasing the demand for the local currency.
  2. Investor Sentiments – Investors’ sentiments play a vital role in determining various outcomes, whether in the stock market or the currency market. It happens because investor views affect the demand and supply of the domestic currency in the international markets, which can contribute to appreciation and depreciation.
  3. Other Factors – Various other factors can lead to currency appreciation, such as terms of trade, recession, government trade, recession nation’s current accounts, speculation, etc.

Impact of Currency Appreciation

Let us understand how currency appreciation can impact an economy.

  1. Decrease in Exports – If the value of a currency appreciates, its goods become more expensive, causing a drop in exports. It may lead to a lowering in the Gross Domestic Product (GDP), which could be seen as unfavourable for the country.
  2. More Imports – As a country’s currency appreciates, imported goods from foreign countries may become cheaper, driving more domestic buyers to purchase international goods.
  3. Trade Deficit – As the value of a currency strengthens, it may result in cheaper imports. Such countries may import more and export less, resulting in a trade deficit.
  4. Lower Inflation – With the value of a currency appreciating, imports may become cheaper and reduced prices may lead to lower inflation.

Currency Appreciation vs Currency Depreciation

Numerous factors may cause currency appreciation and depreciation. Let us understand the critical differences between the two.

CharacteristicsCurrency AppreciationCurrency Depreciation
DefinitionA rise in a country’s currency with respect to other international currenciesA decline in the country’s currency value as compared to other currencies
Imports vs exportsMoney appreciation leads to cheaper imports and causes an increase in demand for imports.The exports become cheaper as a result of currency depreciation. As a result, exports may rise.
Foreign DebtsIn currency appreciation, the cost of funding foreign debt is reduced compared to the national currency.The cost of funding foreign debts with respect to national currency is not reduced in case of currency depreciation.

Conclusion

Currency appreciation denotes the increase in the value of one currency in relation to another currency. As the value of domestic currency appreciates, exports tend to drop, and imports may increase. On the other hand, currency depreciation occurs when a currency’s value falls as compared to other currencies.

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