Does national debt affect the currency exchange rate?

It is important to know the negative implications national debt has on the currency exchange rate in order to avoid additional losses during trying times

National debt is simply the total accumulation of the government’s yearly budget deficits. In other words, it is the net amount a government owes its creditors. If a nation’s national debt increases rapidly in the absence of a strategic crisis plan, it will erode a nation’s currency value. Hence, national debt and the currency exchange rate have a co-dependent relationship. Let us explore common factors that contribute to a nation’s debt and how it inevitably causes a response from the currency exchange rate.

How does national debt affect the currency exchange rate?

1. Trading

The exchange rate plays a critical part in a nation’s ability to perform trades, which is essential to almost every free market economy in this current day and age. If a nation’s value in currency increases, it will make a nation’s imports of goods less pricey and it will make a nation’s exports of goods higher in value in the foreign markets.

If a nation has a lower-valued currency, it will have the opposite effect—it will make a nation’s imports of goods less affordable and exports of goods less valuable in foreign markets. A higher exchange rate can be expected to worsen a country's balance of trade, while a lower exchange rate can be expected to improve it. Exchange rates are significant to the wealth of a nation and are expressed as a comparison of the currencies of two countries. Thus, the exchange rate must be monitored, analysed and measured frequently for a nation to make strategic and impactful trades.

2. Inflation and high interest rates

If a nation’s currency is weak, it will likely increase the inflation rate. This has been evident in nations that are big importers because a higher price of the foreign product will cause the nation’s central bank to raise interest rates to combat inflation and retain the value of the domestic currency. Conversely, a strong currency flattens inflation and helps a nation steer clear of plunging into the deep national debt. Therefore, the exchange rate holds power over the interest rate, which affects one’s everyday living as it determines what you pay for your mortgages, car loan and the interest you receive on the money in your savings.

3. The job market or sector

When the national debt is high, it means there is less room for economic growth. This could lead to fewer jobs created through government funds such as construction work or small business loans. If the job market is inaccessible and it is paired with high interest rates, it will limit spending powers, one’s ability to live comfortably and the overall wealth of a nation, which will weaken the domestic currency.  

One of the most affected industries for consumers will be real estate. People from foreign countries with a stronger currency value will increase housing prices in nations with poorer currency. Imagine this, you have found your dream home but you are forced to bid against people who are getting an automatic discount on the asking price. Even if you are not bidding against people who hold higher currencies, high unit prices are still an issue and you will be faced with a low supply effect on rent too. Thus, we need a strong economy to open up more job prospects. This will increase the wealth of a nation and reduce interest rates. This will also provide more opportunities for the nation in the realm of trading.

4. Investments

Fluctuations in the exchange rate can impact investment portfolios, this goes for both domestic and international investments. A depreciation in the exchange rate stimulates investment by enchanting the demands in domestic and export markets, but it reduces the investment because of the rising price of imported intermediate goods and the user cost of capital.

5. Economic growth

A fiscally responsible government will be able to avoid deep plunges of the national debt, which will make a nation’s currency appear more attractive and stable in its economic growth. To put it simply, national debt can influence the exchange rate in two ways: if a country’s national debt is high, it can limit the value of its currency but if a country’s national debt is low, it will likely be favoured with an increase in currency value. Hence, accessible healthcare, job opportunities, education and social privileges are dependent on a nation’s economic growth.

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