27 Jul The foreign exchange market in international trade

The foreign exchange market is extremely important for both international trade and global investment, as it facilitates transactions and activities in the import and export of goods and services. In addition, the foreign exchange market performs the exchange of currency in a more efficient way and generates appropriate means of payment. For this reason, from small and medium-sized enterprises, transnational organizations, financial institutions and even governments are part of this economic activity with the intention of exchanging and valuing goods and services, which in turn allow the development of foreign trade.

Governments and financial institutions are the main players in the foreign exchange market (Forex or Foreign Exchange Market), where they exchange currencies based on the rules of supply and demand, through private contracts, which originate an OTC market.  (Over the counter). These contracts oblige each party involved to comply with the requirements of the agreed operation, which generates one of the most important financial markets and assets worldwide with more than 5 trillion dollars operated daily.

How does the exchange rate affect Mexican foreign trade?

In the same way as with other countries, foreign trade in Mexico is also affected by the variation of the Mexican peso against other currencies. For example, the appreciation of the Mexican peso against other currencies is synonymous with good results for importing companies and bad results for those that export. On the other hand, if the Mexican peso depreciates, it is an advantage for exporters, since they will make more profit from their sales, while importers will have to pay more for their purchases brought from abroad.

It should be noted that the US dollar is the most used currency in transactions worldwide, mainly for Mexico, because it is the most important trading partner of the United States. For this reason, two scenarios will be analyzed:

• The Mexican peso (MXP) gains value against the dollar (USD)

In this first scenario, the importer is benefited, since the goods and services purchased abroad represent the disbursement of a smaller number of pesos per dollar.  This results in the fact that the volume of imports grows and there is a greater availability of foreign goods in domestic trade.

However, if the opposite happens and the peso becomes excessively strong against the dollar, it affects exporters, since their goods and services will have a higher price on the market, which causes them to lose competitiveness and in the same way originates a reduction in the volume of exports, a possible fall in the productive sector and a decrease in the inflow of foreign currency into the country.

• The Mexican peso (MXP) loses value against the dollar (USD)

In this scenario, the exporters obtain a positive impact, because their goods and services become more competitive compared to the products and / or services offered by other countries.  This results in an increase in the volume of exports, a likely increase in the productive and processing sector, as well as an increase in the inflow of foreign currency into the country, which would generate accumulation of international reserves.

Meanwhile for importers it means negative results, since it causes the increase of their costs and therefore of their prices, which results in the reduction of the domestic market and affects the perception of purchasing power.

Conclusion

The foreign exchange market is the backbone of international trade, since it has been proven above it is fundamental to facilitate import and export operations, providing appropriate means of payment, financial resources, and enhancing additional levels of demand for goods and services.  Also, in the ability to trade in different currencies, the prospects of companies would be limited and global economic growth would be adversely affected.

References

Cinco Días. (2014). El mercado de divisas y su importancia. Extracted from https://cincodias.elpais.com/cincodias/2014/06/10/mercados/1402409907_769859.html [Consulted: July 25, 2022]

El Economista. (2022). El mercado de divisas en el comercio exterior. Extracted from https://www.eleconomista.com.mx/amp/sectorfinanciero/El-mercado-de-divisas-en-el-comercio-exterior-20220718-0026.html [Consulted: July 25, 2022]