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How do currency exchange rates affect investments?

03 March 2022
3 minutes

The currency of a country is a highly volatile asset. It fluctuates depending on several factors like inflation, interest rates, geopolitical stability, the balance of trade, public debt, and the nation’s economic health.

There are so many instances where we hear about news headlines that report how the Rupee has weakened or strengthened against the dollar. Have you ever wondered what the Rupee getting stronger or weaker means, how it affects the market around us, and what impact it has on our investments?

In this blog, we will explore how the currency exchange rate affects your investment.

The foreign investor impact

Foreign exchange rate or exchange rate refers to the price of one currency against another currency. For example, when we say that one dollar equals 75 rupees, it is an expression of one currency relative to another one. If this increases to Rs 78, the Rupee is getting weaker, and the dollar is stronger. Simply put, we have to spend 3 extra rupees to get one US dollar.

Consequently, the global demand for commodities may witness a slump since most of the worldwide trade happens in dollars. This might decrease the value of investments made by a foreign investor in India because most foreign investments happen in the US dollar.

Exchange rate fluctuations can have a negative or a positive impact on investments in a country. The strength of the economy and the currency rates are directly proportional to each other. This means that when the economy is stronger, the currency of that country becomes stronger and global investors are more likely to invest in the stock market of that country. Thus, foreign investors buy assets denominated in the particular asset of the country.

For example, let’s assume you have invested in U.S stocks, and there are reports of the dollar getting weaker against the Rupee. Although your investment in rupees is getting appreciated, the net return would dip since the investment is in a US company.

Impact on retail investors

So what impact does forex fluctuation have on your investment portfolio?

Impact on mutual funds: Firstly, if you have invested in mutual funds where the fund manager has invested the money in foreign stocks or bonds, currency shift is a significant determinant of how your investment in the mutual fund would perform. If the dollar strengthens, this would result in your foreign mutual fund investment appreciating and increasing in value. Similarly, if the dollar weakens, your investment could lose value.

Impact on domestic investments: Nevertheless, if you hold no foreign investments and only domestic assets, you could still be exposed to the currency risk in the global market. Many companies on the stock market have investments in foreign companies; if the currency of that country takes a dip, it could lead to a slump in your investments.

However, many companies also sell their goods and services to different countries that have varying currencies. A decline in the forex could lead to a decline in their profits, which would lead to a negative impact on the company’s performance, and hence, your investment. After all, the company’s earnings from foreign operations would reduce.

An Indian company could be importing some raw material from the U.S. If the dollar strengthens against the Rupee, the company would have to pay more money in rupee terms, increasing their expenses, and denting their net profit. This could result in a poor financial performance which could spill over to its stock performance, affecting your investment portfolio.

The takeaway

Irrespective of whether you invest in foreign stocks or not, forex fluctuations can have a significant impact on your investment portfolio. Of course, individuals with foreign stock and mutual fund investments would take the major hit of currency fluctuations. However, those with domestic assets could also experience the indirect impact of the price volatility.

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