A soft currency is a currency with limited or no convertibility and is subject to large fluctuations due to economic and political factors.
There is such a concept, a hard currency is a strong currency with stable pricing, low inflation and high demand. These include the US dollar, euro, British pound, Japanese yen and some others. Soft currency is the opposite of the term "hard currency". Soft currency, on the contrary, has an unstable pricing due to the economic instability of the issuing state and the political situation in the country, has weak demand due to its instability, high inflation, and lack of free conversion.
The soft currency rate may still depend on the situation on the international market. For example, if the price of energy resources changes sharply, and the country issuing the currency is a key supplier of energy resources, it is obvious that the changes will not be reflected in the best way on the exchange rate. At the same time, positive internal factors (GDP growth, decline in inflation, unemployment, and other macroeconomic improvements) affect the soft currency rate not so strongly. Currency depends more on seasonality, exporters and importers. For example, in some countries, the national currency may strengthen at the time of taxes or harvests.
Soft currency often provokes economic agents to use hard currency, since the former is not stable and does not allow making forecasts for the future. As a result, two monetary systems appear in the country at once:
The first operates on the basis of the Central Bank, where settlements are carried out in the national currency;
And the second, the shadow monetary system, where settlements are carried out in hard currency.
Almost all countries prohibit settlements in foreign currency on their territory, but this does not stop economic entities.
Often, a soft currency is controlled by government agencies, they deliberately adjust the exchange rate so as not to provoke abrupt changes. In this regard, there are again two markets: official and market. In the first, the rate is regulated by the authorities, in the second it is set by the market, they also say "street". This is the rate at currency dealers and exchange offices.
The main problem with a soft currency is a lack of investor confidence. There is a cumulative effect here:
Currency pricing is unstable;
The demand for the currency is lost due to instability;
The volatility of pricing increases due to the loss of demand;
And so in a circle.
How to make hard currency out of soft currency? It is very difficult. It is impossible to artificially regulate the exchange rate or inflation. It is necessary to create legal institutions, a normal judicial system that would protect investors, legislation loyal to investors, develop financial markets, the country's investment attractiveness, and so on. Why is there a huge demand for the dollar? Largely because there is a huge demand for the American stock market. And there is demand for it because of the protection of investors and the development of the market.
What specific currencies can be called soft? Most often, the monetary units of developing countries are referred to as soft currencies. Developing countries are also a rather vague concept. Some of these include those countries that are currently moving to a market economy (roughly speaking, all countries of the former USSR). Others say they are non-OECD countries. For the third, developing countries are states with weaker economies. In any case, if you are from a soft currency country, you probably know about it.
My other way to tell about soft currency
Soft currencyis a rather weak currency, often with low liquidity and weak collateral. Each state has its own national currency and, depending on the economic state in the state, it can have a stable state in relation to world currencies or fluctuate significantly at their level. Currencies of underdeveloped countries are usually referred to as weak currencies, which are greatly devalued, and over time, the number of zeros increases on banknotes. Such a currency is not in demand on currency exchanges, and the inhabitants of these states are forced to independently exchange for hard currency, thereby giving rise to a whole industry of exchange operations and its infrastructure. Foreign exchange reserves are also converted into world currencies, using them during financial and economic crises to support the state's economy.
Soft currencies have certain features, which are expressed in a weak and unstable rate, so its quotation can change significantly right in front of the eyes of traders, while the direction of the fluctuation is oriented towards the deterioration of the rate, that is, its reduction in price. So, within literally a week, the national currency loses in value almost 100%, causing panic and excitement among its residents, who go to hard currencies. The state can even have a hard currency along with the national one. Such currencies usually belong to the economies of countries with a high inflation rate, living on credit funds of international organizations and an unstable political situation within the country. In such countries, coups d'état, armed conflicts are often carried out, and the economy operates with significant disruptions. The state economy is almost always focused on basic necessities, agriculture and the mining industry. It is rather difficult to sell it on the stock exchange, since it is practically not in demand among buyers. And on the territory of even neighboring states it is not possible to use it, due to the lack of trust and reliability criteria. Only the improvement of the economic and political component in the state can bring a soft currency to the status of a hard one. Although this status may vary depending on the region of its use, it can be weak on the scale of the world financial market, and in relation to the region it acquires the qualities of a hard currency in relation to neighboring states. So any solid world currency can lose its status, if armed conflicts and economic problems begin to arise. There are many such examples in history, when the primacy of one currency was replaced by another, stronger and demanded one.
If necessary, on the charts of currency quotes, you can easily determine the status of the currency, whether it is hard or soft. If it sharply changes its course under the pressure of internal or external factors, then it can be safely attributed to soft currencies. Using them in trading is very risky, since they have high volatility, spreads and there is no trust in them in the long run. For example, we can say that soft currencies include almost all currencies of the countries of the former USSR, as well as countries of Latin America, which have significant legislative restrictions on their trade in the market. And some of them are tightly pegged to a hard currency such as the US dollar or euro.