What is Soft Currency?
A soft currency is one with a value that fluctuates, predominantly lower relative to other currencies, because there is less demand for that currency in the forex markets. This lack of demand may be driven by a variety of factors, but is most often a result of the country's political or economic uncertainty.
What Soft Currency Means
A soft currency is one that struggles to maintain its value in relation to other currencies. This happens because traders and investors seek to hold other currencies more than the soft currency. This weak demand is most often a result of the country's political or economic instability, which in turn makes the price of the currency more volatile. Under such conditions forex foreign exchange dealers tend to avoid the currency and traders, even on low volume, can produce drastic swings in the exchange rate of the currency.
In financial markets, analysts and traders will also refer to a soft currency as a "weak currency." Currencies from most developing countries are considered to be soft currencies. Often, governments from these developing countries will set unrealistically high exchange rates, pegging their currencies to a currency such as the U.S. dollar. This policy creates an exchange value that is not favorable to investors or traders, and dampens demand for the currency.
Unsurprisingly, soft currencies are more volatile because of the nature of what drives the movements as well a lack of liquidity brought on by lower demand. Soft currencies are unlikely to be held by central banks as foreign reserves, unlike U.S. dollar, euros and the Japanese yen, a fact which compounds the problems of volatility.
The Zimbabwe dollar and the Venezuelan bolivar are two examples of soft currencies. Both of these countries have experienced political instability. Their governments have instituted monetary policies which have led to hyperinflation. This in turn has led to a sharp devaluation in the currency and the printing of high denominating notes. The annual growth domestic product (GDP) rate in Zimbabwe has fallen every year since 2011, and the Venezuelan economy has been in recession since the first-quarter of 2014. This makes it all the more difficult for these countries to pay their debts on loans they may have taken from banks, other countries, or the International Monetary Fund (IMF).