What Is the Purpose of the Foreign Exchange Market?

China's foreign exchange (forex) market, like its stock market, started relatively late. So why does the forex market exist? What is its significance? The following content may help you find the answer.

Significance of the Forex Market:

1. Trade and Investment
   Importers and exporters deal in different currencies—paying one currency for imports and receiving another for exports. Thus, they need to exchange foreign currencies into their domestic currency. Similarly, overseas investments require currency conversion into the local currency.

2. Hedging
   Companies holding foreign assets face exchange rate risks. If the value of a foreign asset remains unchanged but the exchange rate fluctuates, converting it back to the domestic currency may result in profits or losses. Firms can use hedging tools (e.g., forward contracts) to lock in exchange rates and mitigate potential losses.
   
   

Current Challenges in China’s Forex Market:

1. Limited Market Participants
   Transactions between banks and non-financial clients account for only ~30%, while interbank trading dominates (over 60%), restricting market diversity.

2. Lack of Variety in Trading Instruments & Currencies
   Forex trading is concentrated in major currencies (USD, JPY, GBP, EUR), with limited options.

3. Weak Regulatory Framework
   Due to its late development, China’s forex market lacks effective macroeconomic and legal controls, leading to high volatility.