Foreign exchange earnings refer to the monetary gain made by selling goods and services OR by exchanging currencies in global markets. Such markets are known as Foreign Exchange markets/ Forex markets. Foreign exchange earnings are denominated in convertible currencies, which means that even though the earnings come in the respective currencies of the countries where the products or services are sold, they have to be exchanged with the home currency in order to be calculated.
Foreign exchange earnings can have two components:
(a) Profits from the export of goods and services
(b) Profits from the conversion of currencies due to the difference in exchange rates
The exchange rates of the currencies are a function of the demand and supply of money in a given country and fluctuate with time.
As explained by the money market equilibrium equation (LM curve), if the money supply increases in a country, the price of the currency generally decreases, and the converse holds true. The interest rate, set by the government, also affects the demand for money, and thus the amount of foreign exchange earnings that can be made from it.
Money Market Equilibrium (LM curve) –>L= kY -hi
- L= Money demand
- h= Sensitivity of money demand w.r.t interest
- k=Sensitivity of money demand w.r.t. Y
- Y= Aggregate demand
- i= Interest rate