Foreign Exchange: Definition, Functions, Sources and Types

Definition of Foreign Exchange – The financial sector in a country can be said to be the most important sector in the country’s economic growth. The financial sector is likened to the heart of the country. In other words, if the heart (financial sector) is healthy and stable, economic growth will run smoothly.

The foreign exchange reserves owned by a country are one of the parameters indicating that the country’s financial sector is not experiencing problems and the wheels of the economy are turning well.

Thus, foreign exchange is something that must be given special attention by a country so that the wheels of the economy rotate properly so that developments also run well. Not only that, a country’s good image will emerge when foreign exchange reserves continue to grow.

A. Definition of Foreign Exchange

International trade requires an agreement on means of payment that apply internationally, one of which is foreign exchange. Therefore, every country that wants to or has carried out international trade should have foreign exchange.

According to Law Number 24 of 1999 concerning Foreign Exchange Flows and the Exchange Rate System it is said that foreign exchange is a tool and a source of financing for the nation and state. Meanwhile, according to the Big Indonesian Dictionary (KBBI) foreign exchange is a foreign payment instrument that can be exchanged for foreign money.

Foreign exchange reserves or in English are called foreign exchange reserves, which are deposits from central banks and monetary authorities. Indonesia’s central bank is Bank Indonesia. Meanwhile, Indonesia’s monetary authorities are Bank Indonesia, the Ministry of Finance, and the National Development Planning Agency (Bappenas).

A country that is able to finance imports with foreign exchange reserves is a sign that the country’s financial sector is running stably so that the country can conduct international trade and expand production markets.

If a country has smaller foreign exchange reserves, it is a sign that the country is unable to generate foreign exchange. Therefore, a country must maintain good foreign exchange reserves in order to give a good impression to a country.

Basically, foreign exchange reserves and the domestic economy are interconnected so that they influence one another. If the domestic economy weakens, foreign exchange reserves will decrease. Vice versa, if the economy improves, foreign exchange reserves will increase. Thus, the domestic economy must be managed properly and thoroughly so that the country’s foreign exchange reserves can continue to increase.

B. Foreign Exchange Function

Foreign exchange can be said to be one of the country’s economic strengths, especially in the financial sector. Therefore, a country must be wise when using foreign exchange. Wise use of foreign exchange will benefit the country. The foreign exchange functions that are beneficial to a country are as follows.

1. Foreign debt financing tools

For some countries, especially developing countries, they will pay debts to other countries to meet domestic needs. This is because the country’s income has not been able to meet domestic needs.

The wealth owned by each country is different so that the income of each country will also be different. Good utilization of wealth can be used as a source of state income and can even be used as a state foreign exchange reserve.

These foreign exchange reserves can be used as financing to pay off foreign debt. If the state debt has been paid, the foreign exchange reserves are used for economic growth, development, and others.

2. Means of payment for international trade

Lots of countries want to introduce their superior products and market them to the global market so that international trade emerges. With international trade, the country’s income can increase.

One of the important things in international trade is export and import activities. When carrying out export and import transactions, a means of payment is required, namely foreign exchange. This foreign exchange is often used as a means of payment for international trade because of its convenience when used and transactions can be accomplished.

Thus, the foreign exchange used when carrying out international trade transactions can be used as a second currency for a country.

3. International relations financing tool

Every country must have good relations with other countries. Good relations between two or more countries will make it easier for a country to establish cooperation.

To establish relations with other countries requires operational costs, such as activities carried out abroad, official travel abroad, and diplomatic activities between countries. This operational cost can be financed through foreign exchange.

The use of foreign exchange when carrying out international relations must be carried out wisely and maximally so that no foreign exchange is wasted.

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4. As a Source of State Revenue

Most of the function of foreign exchange is used as a means of payment and financing. Starting from international trade payments to financing to establish international relations.

Unlike the other foreign exchange functions, the last foreign exchange function is used as a source of state revenue. With foreign exchange, domestic development can be carried out, the financial sector will be stable, and economic growth will be maintained.

The function of foreign exchange as a source of state revenue must be maintained properly so that state revenue does not decrease and is even expected to increase.

Sources of foreign exchange can be obtained domestically. Therefore, the sources of foreign exchange that exist in the country must be maximally obtained so that foreign exchange functions can be carried out.

C. Sources of Foreign Exchange

Every foreign exchange in a country must come from the largest source of income. That is, if a country excels in the tourism sector, that country will maximize the growth of the tourism sector so that many foreign tourists or local tourists come so that the country gets a high source of foreign exchange. High sources of foreign exchange will maintain the stability of foreign exchange reserves owned by a country.

The source of foreign exchange is not only in the tourism sector, but there are other sources of foreign exchange. Check out the foreign exchange sources as follows.

1. Export of goods and services

Export activities of both goods and services are a source of foreign exchange that can be relied upon because from this activity there will be many benefits for a country, such as introducing superior products that are sold at competitive prices.

Thus, the more goods or services that are exported, the income of a country will continue to increase so that foreign exchange reserves will be stable and tend to increase. Therefore, the government in a country needs to maximize this export activity.

2. Foreign aid

Loans or assistance originating from abroad are usually in the form of money because money is considered more significant as a source of foreign exchange for the country. However, sometimes there are several countries that send aid in kind.

Assistance in the form of goods is also very meaningful for a country, but can only be used to save foreign exchange. This is because a country that is given assistance in the form of goods does not need to issue foreign exchange reserves (money) to buy these goods.

3. Private funding

Sometimes there are several countries that use funds from the private sector as a source of foreign exchange. The source of foreign exchange provided can be in the form of money or in the form of development investment so that when building something, the state does not need to spend funds. One example of development carried out by the private sector is the Integrated Average Mode (MRT).

4. Foreign debt

For some developing countries that have not been able to generate maximum foreign exchange reserves, they will need loans from abroad. Thus, borrowed funds from abroad will be recorded as state debt as well as a source of state foreign exchange reserves.

Therefore, these loan funds must be used optimally so that foreign exchange reserves remain stable and can increase so that these debts can be paid.

5. Tourism

There are several countries that rely on the tourism sector as a source of foreign exchange income, one of which is Indonesia. Tourism in Indonesia is well known to foreign countries so many tourists want to travel to Indonesia. Bali is the most visited area in Indonesia because it has stunning natural beauty.

When traveling, foreign tourists will exchange their money so that it can be used in the country of visit. The money earned when tourists travel will be used as a source of foreign exchange for a country. In other words, foreign exchange earnings from the tourism sector will increase if tourists coming from abroad continue to grow.

6. Import duties

Goods coming from abroad when entering the country will be subject to an entry fee. This entry fee is often known as import duty. This import duty is a potential source of foreign exchange.

The more goods that enter the country, the more income the country will get through the import duty sector. Thus, a country needs to optimize this import duty sector because it is a source of foreign exchange and can increase foreign exchange reserves.

D. Types of Foreign Exchange

After explaining the meaning of foreign exchange and the sources of foreign exchange, it is incomplete if you don’t discuss various types of foreign exchange. By knowing the various types of foreign exchange, it will be easy for us to distinguish the categories of foreign exchange. See an explanation of the following types of foreign exchange.

1. General foreign exchange

General foreign exchange is foreign exchange obtained through credit or international trading activities such as exports and imports, receipt of capital, procurement of services, and others. Thus, this foreign exchange is like borrowing a debt so that when you owe it, you have to repay the debt.

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2. Foreign exchange credit

The similarities between credit foreign exchange and general foreign exchange are that they both have to repay debts and what distinguishes these two foreign exchanges is the flow of funds. Funds from general foreign exchange are usually used to advance a company or improve the quality of production.

Meanwhile, credit foreign exchange is foreign exchange obtained from credit or foreign loans. However, funds obtained from foreign exchange credit are usually used for the benefit of the community, such as money loans for MSMEs that have low interest rates.

3. State foreign exchange

State foreign exchange is foreign exchange owned by the government of a country. The country’s foreign exchange is obtained from exports, taxes, import duties, and others. It is important for a country to pay attention to the country’s foreign exchange so that foreign exchange reserves will continue to exist and even increase. Well-maintained foreign exchange reserves will maintain the stability of the country’s economy.

4. Complementary foreign exchange

Complementary foreign exchange is foreign exchange owned by the private sector, but the use of this foreign exchange is supervised and regulated by the government. Usually, complementary foreign exchange is generated through the sale of services (forex).

5. Export foreign exchange

Export foreign exchange is the same as complementary foreign exchange, but what distinguishes the two types of foreign exchange is the source. The source of export foreign exchange is foreign exchange resulting from the export of visible goods. The export foreign exchange used must comply with the applicable foreign exchange regulations.

The use of foreign exchange by the government or the private sector can be said to be good if it has been supervised. Monitoring the use of foreign exchange can prevent foreign exchange reserves from being wasted. If there is a waste of foreign exchange reserves, foreign exchange reserves can be depleted and can give a bad image to the country.

E. Forms of Foreign Exchange

Foreign exchange takes three forms, namely securities, foreign money orders, and foreign currency. Check out the explanation of the following forms of foreign exchange:

1. Securities

Securities are documents that have value and are protected by law and the state. Securities must be properly guarded so that nothing is lost. For example, bonds, stocks, and commercial papers.

2. Foreign bills of exchange

A money order is something that is sent from abroad by Indonesian Migrant Workers (TKI) to their beloved families who live in Indonesia. Families in Indonesia will definitely be happy because they can receive something from abroad.

These TKI are usually called foreign exchange heroes because the large amount of foreign exchange sent to Indonesia will go into the state treasury.

3. Foreign exchange

As we already know that not all domestic currencies can be used as a means of international payment transactions. Therefore, when conducting international trade, a country must use foreign currency. Foreign exchange is the second currency that can be used in international trade transactions.

This form of foreign exchange (foreign exchange) can be obtained from foreign credit, credit foreign exchange, credit general foreign exchange. How to use foreign exchange?

In simple terms, foreign currency will be used if foreign parties want compensation or payment in the form of US currency, namely dollars or other foreign currencies that have more stable exchange rates, such as pounds or yen. Therefore, for Indonesian companies wishing to cooperate with foreign companies, they need to purchase foreign currency at a foreign exchange bank and can be paid using rupiah.

F. Benefits of Using Foreign Exchange

Foreign exchange reserves could run out if they are used without regulation and supervision, which can make it difficult for the wheels of the economy to turn so that national development is hampered. Therefore, the use of foreign exchange must be used wisely so that foreign exchange reserves will not run out and the benefits can be achieved. The following are the benefits of using foreign exchange.

  • Can be used to finance trade transactions for imported goods and services;
  • Can overcome foreign obligations for the purchase of securities by domestic investors;
  • Can be used to make payments on overdue foreign loans (debt);
  • Can be used to finance existing or residing government representatives abroad;
  • Can be used to carry out cultural, artistic and sports missions abroad.

G. Conclusion

Foreign exchange reserves are the financial sector owned by a country and function as a means of payment for international trade, payment of foreign debts, financing of international relations, and a source of state revenue. The stability of foreign exchange reserves must be properly maintained so that economic growth and development on a national scale can run well.

Foreign exchange earnings can be obtained through six sources, namely export of goods and services, assistance from abroad, private funding, foreign debt, tourism and import duties. Foreign exchange takes three forms, namely foreign currency, securities, and bills of exchange from abroad.

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Author : Restu Nasik Kamluddin