The strength of a currency is an indication of the stability of the country issuing it. Weakness of the domestics currency can result in an economic crisis, as happened in Asian Financial Crisis of the nineties. The strength currency is determined by a a complex interaction of market forces and economic policies adopted by Central Banks and Governments.
What do we mean by the strength of the currency?
The strength of the currency is nothing but the price of that currency in terms of other currencies. In international markets, this price is decided just like the price ofany other commodity in the market, by the relative demand and supply. If there are more buyers wanting to buy the currency relative to the amount of the currency available for supply by the suppliers of that currency, the price of that currency will rise, meaning thereby that the currency will strengthen. If, on the other hand, the supply of the currency exceeds what the buyers are wanting to buy, then the currency will weaken, meaning its price will reduce.
Demand for Currency
The demand for a currency is created by two factors, its exports that the others want to buy, or the investments that people want to make in that currency or assets denominated in that currency. So rising exports lead to rising demand of that currency and consequent strengthening of that currency. Greater capital inflows and investments within from outside have the same effect of increasing demand and strengthening the
Currency markets and Expectations
The currency market is sensitive to both future expectations and speculators. If the economy of a country is not doing well, fewer people will wish to invest there, so the currency of that country will fall. On the other hand if, for some reason, people expect that the currency will fall, they will take their investments out, and so actually make the currency fall.
Role of Governments
But the market is seldom allowed to operate freely by the governments, who keep sure that the value of their currencies in the international market do not fluctuate too much. Generally they decide a band in which they want their currencies to remain, and then, through their central banks or monetary authorities, they intervene in the market to ensure price remains where they want it to be. So if on a particular day, the value of the currency is falling more than what is acceptable, the concerned central bank starts buying the currency. If the currency is appreciating too much, it starts selling it.