ADVERTIsem*nTS:
Demand for Foreign Exchange: Meaning, Reasons and Demand Curve Diagram!
Meaning:
The demand (or outflow) of foreign exchange comes from those people who need it to make payment in foreign currency.
ADVERTIsem*nTS:
It is demanded by the domestic residents for the following reasons:
1. Imports of Goods and Services:
Foreign Exchange is demanded to make the payment for imports of goods and services.
2. Tourism:
ADVERTIsem*nTS:
Foreign exchange is needed to meet expenditure incurred in foreign tours.
3. Unilateral Transfers sent abroad:
Foreign exchange is required for making unilateral transfers like sending gifts to other countries.
4. Purchase of Assets in Foreign Countries:
ADVERTIsem*nTS:
It is demanded to make payment for purchase of assets, like land, shares, bonds, etc. in the foreign countries.
5. Speculation:
Demand for foreign exchange arises when people want to make gains -from appreciation of currency.
Reasons for ‘Rise in Demand’ for Foreign Currency:
The demand for foreign currency rises in the following situations:
ADVERTIsem*nTS:
1. When price of a foreign currency falls, imports from that foreign country become cheaper. So, imports increase and hence, the demand for foreign currency rises. For example, if price of 1 US dollar falls from Rs 50 to Rs 45, then imports from USA will increase as American goods will become relatively cheaper. It will raise the demand for US dollars.
2. When a foreign currency becomes cheaper in terms of the domestic currency, it promotes tourism to that country. As a result, demand for foreign currency rises.
3. When price of a foreign currency falls, its demand rises as more people want to make gains from speculative activities.
Demand Curve of Foreign Exchange:
Demand curve of foreign exchange slope downwards due to inverse relationship between demand for foreign exchange and foreign exchange rate.
In Fig. 11.1, demand for foreign exchange (US dollar) and rate of foreign exchange are shown on the X- axis and Y-axis respectively. The negatively sloped demand curve (DD) shows that more foreign exchange (OQ1) is demanded at a low rate of exchange (OR1), whereas, demand for US dollars falls to OQ2 when the exchange rate rises to OR2.
