Fixed Exchange Rate vs. Indicative Exchange Rate
Fixed Exchange Rate vs. Indicative Exchange Rate
If you want to send money to India, one of the most important things you need to consider is the exchange rate. Gaining an understanding about the prevalent exchange rates will give you an insight into how your transaction can be processed.
What is a fixed exchange rate?
A fixed exchange rate is when a particular country ties its currency value to a widely used currency or commodity. For most transactions in international trade, the dollar is used as the currency. When you understand what is fixed exchange rate, you can consider its advantages and disadvantages to the economy.
Advantages of a fixed exchange rate
One of the most important advantages of fixed exchange rate is that it provides currency stability. Every investor will know what their currency is worth and this will make the businesses of the country attractive to foreign direct investors. Since the value is fixed, the investors will not worry about protecting themselves from swings in the currency’s value. It is possible for a country to avoid inflation if it follows a fixed exchange rate and fixes the currency to a popular one like US dollars.
Disadvantages of a fixed exchange rate
One of the disadvantages of fixed exchange rate is that it is very difficult to maintain. It costs more and a country should have adequate foreign exchange reserves in order to manage the currency’s value. With a fixed rate, the country can become an easy target for speculators. The bank will have to convert the foreign exchange in order to prop the value of their currency.
What is an indicative exchange rate?
An indicative exchange rate is also known as a floating exchange rate. It fluctuates as per the market forces of supply and demand. Any change in the market condition will cause the exchange rate to fluctuate. Neither the Government nor the central bank will interfere in the determination of the rate of the currency. It is very flexible and cannot be locked during a transaction.
Advantages of an indicative exchange rate
After you understand what is floating exchange rate, you can learn about the pros and cons of the rate. An advantage of this type of exchange rate is that it allows automatic stabilization in the economy. There is no need for the interference of a third-party and the economy remains free from any crisis. It is highly flexible and can help avoid inflation in a country.
Disadvantages of an indicative exchange rate
One of the major disadvantages of floating exchange rate is the uncertainty and the speculation related to the currency. Since the currency’s value changes from day to day, it brings uncertainty during trade, and this gives rise to speculative measures. There is also a lack of investment because people cannot judge how the currency will change with regard to the market conditions.
It is important to understand the difference between two exchange rates i.e. fixed vs. floating. Both have advantages and disadvantages that should be looked into. There are many who find a fixed exchange rate to be much more stable and reliable as compared to a floating exchange rate.
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