Foreign Exchange: Definition, Types, Functions and Examples

Last updated on June 7th, 2024 at 03:24 pm

You may already be familiar with the term "foreign exchange" or "devisa." But what exactly does it mean, what are its types, and what is its important role in the world economy? Here, we will break down everything related to foreign exchange. Read on to understand more!

What is Foreign Exchange (Devisa)?

Foreign exchange refers to foreign currency used in transactions in another country. For example, the US Dollar is used in Indonesia when you travel there.

Foreign exchange is also crucial for determining exchange rates and economic stability. Simply put, foreign exchange is a foreign currency that plays a role in international transactions and the economy of a country.

Types of Foreign Exchange

Foreign exchange can come in several forms, such as foreign currency (also known as "valuta asing"), gold, and securities. Here’s a breakdown of the types:

1. Foreign Currency (Valuta Asing): Refers to foreign currency recognized and used as a medium of exchange in countries other than the country of origin of the currency.
2. Gold: Represents foreign exchange in the form of precious metals, such as gold bars or coins, which have high intrinsic value and are accepted as investments or stores of value.
3. Securities: Includes financial instruments such as bonds, certificates of deposit, or foreign stocks that can be liquidated and have value in international financial markets. For more information about these financial instruments and their role in financial transactions, you can read about Telegraphic Transfer. 

Functions of Foreign Exchange

The functions of foreign exchange are very important in the economic context of a country. Here are the key functions of foreign exchange:

1. International Payment Medium: Foreign exchange serves as a medium of payment in international trade, facilitating export and import transactions.
2. Foreign Exchange Reserves: It is used as an external reserve by the government to maintain currency stability and mitigate economic risks, such as trade deficits.
3. Foreign Investment: Foreign exchange enables foreign investments in a country's financial markets and economic sectors, promoting economic growth and job creation.
4. Repayment of Foreign Debt: Foreign exchange is used to pay foreign debts, including both principal and interest payments to foreign creditors.
5. Tourism and Travel: Foreign exchange is generated from the tourism sector, where foreign tourists spend money in the country, helping to increase the nation's foreign exchange revenue.

These functions help maintain economic balance and financial stability at both national and international levels.

Types of Foreign Exchange Reserves

Foreign exchange reserves come in several categories, each serving different roles in managing a country’s economy. Here’s a brief explanation of the types of foreign exchange:

General Foreign Exchange

Refers to foreign currency used for general purposes and everyday international transactions.

Credit Foreign Exchange

Foreign exchange provided in the form of credit or loans to support international trade or investment projects.

State Foreign Exchange

Foreign exchange used to meet overseas needs not related to trade, such as paying foreign debt or travel expenses.

Export Foreign Exchange

Foreign exchange used to meet overseas needs not related to trade, such as paying foreign debt or travel expenses.

Devisa Ekspor

The amount of foreign exchange held and saved by the government or central bank to maintain economic and financial stability, as well as for emergency use or foreign debt payments.

Foreign exchange reserves

The amount of foreign exchange held and held by a country's government or central bank to maintain economic and financial stability, as well as for use in emergencies or for payment of foreign debt.

Each type of foreign exchange plays a special role in managing a country's economy, and its management must align with economic policies and national needs.

Read Also: Cross Border Transactions

Benefits of Foreign Exchange

The benefits of foreign exchange are significant in the context of a country’s economy, both on a macroeconomic and microeconomic scale. Here are some of the main benefits of foreign exchange:

1. Increasing Foreign Exchange Reserves
2. Facilitating International Trade
3. Encouraging Economic Growth
4. Supporting Tourism
5. Investment and Capital Development
6. Paying Foreign Debt
7. Crisis Management
8. Paying for Business Travel Expenses

The wise utilization of foreign exchange is crucial for achieving sustainable economic growth and improving overall societal welfare.

Examples of Foreign Exchange

Some popular examples of foreign exchange currencies used globally include the US Dollar (USD), Euro (EUR), Japanese Yen (JPY), British Pound (GBP), Chinese Yuan (CNY), and Swiss Franc (CHF).

Regionally, currencies like the Indonesian Rupiah (IDR), Malaysian Ringgit (MYR), and South Korean Won (KRW) also play an important role in international transactions. Each of these currencies has its own unique story and characteristics that influence global economic movements.

Sources of Foreign Exchange

The sources of foreign exchange are the activities that bring foreign currency into a country. Some sources of foreign exchange include: 1. Export of goods and services 2. Remittances from migrant workers 3. Foreign direct investments 4. Foreign loans 5. Income from foreign investments 6. The tourism industry 7. Sale of securities 8. Portfolio investments 9. Commodity trade such as gold and silver

The government optimizes these foreign exchange sources to strengthen the economy and maintain the country’s financial stability.

Mechanism of Foreign Exchange

The foreign exchange mechanism refers to the system that regulates the inflow and outflow of foreign currency within a country. Its purpose is to ensure the effective and efficient management of foreign currencies and to maintain the country's economic and financial stability.

The government and central banks manage this mechanism to keep the country’s economy stable, including monitoring transactions and currency exchange rates.

From the explanation above, we can understand just how vital foreign exchange is in driving the global economy. Every exchange rate, every trade transaction, and every historical economic shift is part of a larger narrative involving foreign exchange.