Foreign exchange represents a system with the help of which trading countries settle their international indebtedness and includes all institutions, credit instruments mechanism etc. Foreign exchange is a very important element in foreign trade. Its importance from national point of view can be discussed as follows.
Importance of Foreign Exchange:
(i) Foreign exchange situation of a country indicates the strength of the economy. If it possesses large reserves of foreign exchange, it is an indication of developed economy whereas tight foreign exchange position. indicates an underdeveloped economy. Thus, foreign exchange position is indicative of the stage of development.
(ii) Shortage of foreign exchange refers to the position of adverse balance of payments and Its surplus a position of favorable balance of payments. In case of adverse balance of payments situation, the central bank or the government must try to balance the situation by increasing its exports and restricting the outflow of foreign currency.
(iii) Foreign exchange simplifies the complexities arising out of the vast participation of nations in the international trade. Payments are easily made on the mutually accepted and predetermined rates. Thus, it makes the international trade easy.
(iv) The foreign exchange ‘ratio shows a direct relationship between the prices of the commodities in the national and international markets.
(v) Foreign exchange position shows a comparative soundness of two nations. A hard-currency nation is certainly a sound nation for the other country for which the currency of that nation is not easily available. For example, for India, American Dollar and British Pound-sterling are hard currencies. It means, the economies of America and Britain are certainly richer.
(vi) The stability in exchange rates, is of high importance without which various other problems may crop up. Instability in exchange rate may lead a country to devaluation or revaluation.
Thus, problem of foreign exchange is very important in foreign trade especially for developing nations because they have paucity of foreign exchange to meet their foreign exchange liability. They are required to restrict the outflow of foreign exchange very carefully.
