the challenges and possibilities

Introduction
• Foreign currencies are brought and sold in the
foreign exchange market. Spot transaction
and forward transactions are executed in the
forex market.
• Spot transactions result in the delivery of the
foreign currencies immediately or within a
couple of days, where as forward transactions
are agreements to deliver the foreign
currencies at a future date.
• International business necessitates exchange of
different currencies between people and
organization.
• Currency exchange take place on the basis of
exchange rates.
• A exchange rate is the value of one currency in
terms of another currency.
• Exchange rate is influenced by a number of
economic factors, It determined on the basis of
certain systems and is controlled by the monetary
authorities of each country.
 The Foreign Exchange Market
• The Indian Rupee has been convertible on the trade account since
August 1994. Capital inflows on one side and the Reserve Bank
of India on the other have kept it sandwiched at 31.37 INR to the
US dollar since around August 1992. The spot market is
incredibly liquid, but this is largely a consequence of there being
a last resort buyer (the Reserve Bank of India) and supply
generally exceeding demand. However, even on exceptional days,
it is fairly easy to buy USD 100 million or so during the day.
Selling is not a problem at all, as the Reserve Bank has been the
last resort buyer.
 Indian foreign exchange market
• The Indian foreign exchange market consists of the buyers,
sellers, market intermediaries and the monetary authority of India.
The main center of foreign exchange transactions in India is
Mumbai, the commercial capital of the country. There are several
other centers for foreign exchange transactions in the country
including Kolkata, New Delhi, Chennai, Bangalore, Pondicherry
and Cochin. In past, due to lack of communication facilities all
these markets were not linked. But with the development of
technologies, all the foreign exchange markets of India are
working collectively
Main foreign exchange market turnover,
1988–2007, measured in billions of USD
 Foreign Exchange Transactions
• The foreign exchange market in India is growing in both volume and
depth. Various kinds of transactions are facilitated by the banks both
on a spot and on a forward basis. These include hedging transactions
such as currency swaps and interest rate swaps.
• Foreign and Indian banks also assist in offshore loan syndication.
Other services provided include, financing of foreign trade, arranging
the most economical source of supplier credit, etc. Banks also assist in
foreign exchange management such as currency management
strategies and designing, assessing of liability structures vis-a-vis
swaps, interest rates, income, etc
Most traded currencies
 India’s Exchange Rate Experience
 In 1972, when the pound was floated, the rupee kept parity with the British
pound
 Between 1975 and 1991 India followed the basket of currency system, with the
British pound as the currency of intervention
 This was a managed float with a margin of +/- 5 percent with a ‘discretionary’
crawling peg
 The basket peg reduced exchange risks compared to the earlier pound peg, but
did not eliminate the risk
 In 1991, during the BOP crisis, the RBI brought about a sizeable downward
adjustment of the rupee value
 LERMS – Liberalized Exchange Rate Management System – 50% of the
currency was freely convertible at market exchange rate, and 50% under a
managed float
 1993 Unified Exchange Rate System
 Convertibility of the rupee under current account
 No full convertibility and capital account convertibility
10
 Exchange rate systems

• Fixed rate system

• Freely floating rate system
• Managed floating rate system
• Pegged rate system
 Fixed exchange rate system
• In a fixed exchange rate system, the exchange
rates between the home currency and other
foreign currencies are held constant and are
allowed to fluctuate only with in narrow bands.
• When exchange rates move beyond the permitted
boundaries, the monetary authorities of the
country intervene to maintain the exchange rates
within the boundaries.
Flexible Exchange Rate
 In a flexible exchange rate system, the central bank allows
the exchange rate to adjust to equate the supply and demand
for foreign currency. In effect since 1973
 Clean floating – the central bank stands aside completely and
allows the exchange rate to be freely determined in the forex
market – official reserve transactions are zero
 Managed float - the central bank intervenes to buy or sell
foreign currencies periodically in an attempt to influence the
exchange rates
 Snake in the lake
 Snake in the tube

15
 Flexible Exchange Rate
Exchange rate

$2
E2

E1 $1 $”

E $’
$
D2

D1
D

Quantity of dollars
16
History of Flexible Exchange Rate
• Collapse of the Bretton Woods system in 1971 when the
US Treasury refused to convert short-term liabilities into
gold and made dollar inconvertible
• 48 countries including the US, Japan, many EU countries
abandoned the fixed exchange rate
• Group of Ten industrialized countries met at the
Smithsonian Institute in Washington, DC in December
1971; agreed to a new system of stable exchange rate
with wider bands – US devalued 8%, Japan revalued
17%, Germany revalued 14% - allowed 2.25 %
fluctuation plus/minus;1973 fluctuation widened to 4.5%
• US devalued again in Feb 1973 – Smithsonian
Agreement collapsed
• ECU 1979, euro 2001 17
 Pegged exchange rate system
• In this system ,the value of the home
currency is pegged to a specific foreign
currency.
• US $
 Foreign Exchange as a Tool of Monetary
Policy
✔ Foreign currency market operations>>>Exchange rate
 In addition to government bonds, RBI buys and sells foreign currency;
 If RBI buys dollars/yen/euros/pounds etc., it increases MS
 If RBI sells forex, it decreases MS
 Buying or selling forex affects the exchange rate
✔ Sterilization
 Sometimes RBI wants to sell foreign currency to support the rupee, but does
not wish the MS to fall
 To do this, RBI uses the rupee it acquires to buy government bonds, thus
putting the rupee back into circulation
 This process of offsetting foreign exchange market operation with an open-
market operation is called sterilization

19
 Conclusion
The foreign exchange market is one of
the important components of international financial
system. The regulatory framework for foreign
exchange management in India is contained in the
Foreign Exchange Management Act (FEMA) and
the institutional support is given by RBI .The
Indian foreign exchange market has now become
quite vibrant with the rapid economic development
of the country.