Under the exchange rate relationship, both appreciation and depreciation are relative to foreign currency. The appreciation of RMB against the US dollar is beneficial to imports, while the depreciation of RMB against the US dollar is beneficial to exports.
When the RMB exchange rate rises, that is, the RMB appreciates and the US dollar depreciates, China's export commodities will become more expensive (priced in US dollars) in the international market, foreigners will spend more US dollars to buy, and fewer people will buy China's commodities, so exports will also decrease, and the corresponding enterprises will get less US dollars, so that the central bank can potentially buy less foreign exchange and the foreign exchange reserves will decline.
When the RMB exchange rate falls, that is, the RMB depreciates and the US dollar appreciates, everything is just the opposite. China's exports are cheaper, the dollar in the foreign exchange market will increase, and the foreign exchange reserves will also increase.
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As a basic reflection of a country's borrowing situation, interest rate plays a decisive role in exchange rate fluctuations. The interest rate level has a direct impact on international capital flows. Capital inflows occur in countries with high interest rates and capital outflows occur in countries with low interest rates. Capital flow will change the relationship between supply and demand in the foreign exchange market, thus affecting the fluctuation of foreign exchange rate. Generally speaking, the increase of a country's interest rate will lead to the appreciation of its currency, and vice versa;
All the theories of the monetary school have discussed the role of interest rates in exchange rate fluctuations. However, the most clear explanation is the interest rate evaluation theory, which emerged after the 1970s. This theory well explains the exchange rate changes in the short and medium term. The influence of interest rate on exchange rate is mainly realized through the influence on arbitrage capital flow.
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