Forecasting Exchange Rate Changes

In establishing an exchange threat management system, economic managers will have to have information and facts on the prospective direction, timing, and magnitude of exchange rate alterations. Advised of exchange rate prospects, economic managers can extra effectively and proficiently arrange proper defensive measures. No matter if it is actually probable to accurately predict currency movements, having said that, remains an concern.Information frequently used in making exchange rate forecasts (e.g., currency depreciation) relates to changes in the following factors: Inflation differentials. Evidence suggests that a higher rate of inflation in a given country tends, over time, to be offset by an equal and opposite movement in the value of its currency.
Monetary policy. An increase in a country’s money supply that exceeds the real growth rate of national output fosters inflation, which affects exchange rates.
Balance of trade. Governments often use currency devaluations to cure an unfavorable trade balance (i.e., when exports or imports).
Balance of payments. A country that spends (imports) and invests more abroad than it earns (exports) or receives in investments from abroad experiences downward pressure on its currency’s value.
International monetary reserves and debt capacity. A country with a persistent balance of payments deficit can forestall a currency devaluation by drawing down its savings (i.e., level of international monetary reserves) or drawing on its foreign borrowing
capacity. As these resources decrease, the probability of devaluation increases.
National budget. Deficits caused by excessive government spending also worsen inflation.
Forward exchange quotations. Aforeign currency that can be acquired for future delivery at a significant discount signals reduced confidence in that currency.
Unofficial rates. Increases in the spread between official and unofficial or black market exchange rates suggest increased pressure on governments to align their official rates with more realistic market rates.
Behavior of related currencies. A country’s currency will normally behave in a fashion similar to currencies of countries with close economic ties to it. 

Interest rate differentials. Interest rate differentials between any two countries predict future change in the spot exchange rate.
Foreign equity option prices. Since arbitrage links a foreign equity’s price in its home market with its domestic currency value, changes in the domestic currency option price of a foreign equity signals a change in the market’s expectations of future FX rates.
These items help forecast the course of currency movements. Having said that, they are usually not sufficient to calculate the right time and magnitude of currency alterations. Politics strongly affects currency values in many countries. Politics responses to devaluation or revaluation pressures regularly lead to temporary measures rather than exchange rate changes. These non permanent measures include particular taxes, import controls, export incentives, and exchange controls. Awareness of the politics of a nation whose currency is under pressure is important. It helps economic managers discern no matter if the government will lean toward market intervention or rely on free-market solutions. Several declare that exchange rate predicting is a futile exercise. Within a world where exchange rates are free to change, FX markets are mentioned to become efficient. Current market rates (i.e., forward exchange rates) represent the consensus of all market individuals about future FX rates. Information and facts that is generally available is instantly impounded in current FX rates. Thus, such information and facts has little worth in predicting future exchange rates. Under these conditions, FX rate alterations are random responses to new information and facts or unforeseen events. Forward exchange rates are the best available estimates of future rates. The randomness of FX rate alterations reflect the diversity of opinions on exchange beliefs by participants What do all of these components imply for management accountants? For one thing, accountants will have to develop systems that gather and process comprehensive and accurate information and facts on variables correlated with exchange rate movements. These systems can incorporate information and facts provided by external forecasting services, economic publications that track currency movements, and daily contacts with foreign currency dealers. They should really be online and computer-based to ensure managers an excellent method to obtain information and facts on which to base their currency forecasts. Economic managers will have to also understand the consequences of not using other forecasting methods. If exchange rate predicting is not probable or too costly to undertake, then economic managers and accountants should really arrange their company’s affairs to minimizethe detrimental effects of rate alterations. This process is known as exposure management.