indian exchange rate policy

8/14/2019 Indian Exchange Rate Policy

1/70

Presented By:

[5] Aniket Banerjee [11]Mitesh Chawhan

[23] Kirankumar Jathar [25] Sunil Kale

[29] Anuja Khandekar [35]Prashant Mali

[41] Harshvardhan Pandere [47]Umesh Rai

[53] Vi a ra Shett [59]


2/70

It is rate between two currenciesspecifies how much one currency is

worth in terms of the other. It is the value of a foreign nations

currency in terms of the home

nations currency. USD $ V/s Rs.


3/70

Exchange rate is also known asForeign exchange rate or Forex rate.

The foreign exchange market is oneof the largest markets in the world.

By April2007, daily turnoverwas reported to be overUS $ 3.2 trillion.


4/70

Exchange rate is also known asForeign exchange rate or Forex rate.

The foreign exchange market is oneof the largest markets in the world.

By April2007, daily turnover wasreported to be over US $ 3.2 trillion.


5/70

Spot exchange rateIt refers to the current exchange rate and

quoted for immediate delivery of foreign

exchange .Forward exchange rate It refers to an exchange rate that is quoted

and traded today but for delivery and

payment on a specific future date. Premium on currency

Discount on currency

Buying rate

Selling rate


6/70

Nominal exchange rate the rate atwhich we can trade the currency of onecountry for the currency of another

Real exchange rate the rate at whichwe can trade the goods and services ofone country with the goods and services

of another.Real exchange rate = (nominal

exchange rate X domestic price) /(foreignprice).


7/70

It is the record of all transactions ofthe residents with the rest of the

world and vice versa.Equilibrium exchange rate depends

on

Demand for and supply of currencyin forex market.

And demand and supply of foreignexchange arise from debit and

credit item in BOP.


8/70

Measures the price of a basket ofgoods and services availabledomestically relative to the same

basket available abroad purchasing power parity.


9/70


10/70

Prices of a Big Mac burger in McDonald'srestaurants in different countries.If a Big Mac costs US$4 in the United States andGBP 3 in the United Kingdom, the PPP exchangerate would be 3 for $4.


11/70

Devaluation the price of foreigncurrencies under a fixed exchange rateregime is increased by official action

Revaluation - the price of foreigncurrencies under a fixed exchange rateregime is decreased by official action

Depreciation under a floating ratesystem, price of foreign currenciesincreases because of market adjustment

Appreciation - under a floating ratesystem, price of foreign currenciesdecreases because of market adjustment


12/70

Early Stages: 1947-1977

Formative Stage: 1978-1992

Post-Reform Stage: 1992 onwardsEarly Stages: 1947-1977

The evolution of Indias foreign exchange market may be viewed in

line with the shifts in Indias exchange rate policies over the lastfew decades from a par value system to a basket-peg andfurther to a managed float exchange rate system.During the period from 1947 to 1971, India followed the par value

system of exchange rate. The Reserve Bank maintained the par

value of the rupee within the permitted margin of 1 per cent usingpound sterling as the intervention currency. Since the sterling-dollar exchange rate was kept stable by the US monetary authority,the exchange rates of rupee in terms of gold as well as the dollarand other currencies were indirectly kept stable.

HISTORICAL PERSPECTIVE


13/70

The devaluation of rupee in September 1949 andJune 1966



14/70

Early Stages: 1947-1977Given the fixed exchange regime during this period, the foreign exchange market for

all practical purposes was defunct.The objective ofexchange controls was primarily to regulate the demand forforeign exchange for various purposes, within the limit set by the available supply.The Foreign Exchange Regulation Act initially enacted in 1947 was placed on apermanent basis in 1957.

In terms of the provisions of the Act, the Reserve Bank, and in certain cases, theCentral Government controlled and regulated the dealings in foreign exchangepayments outside India, export and import of currency notes and bullion, transfers ofsecurities between residents and non-residents, acquisition of foreign securities.With the breakdown of the Bretton Woods System in 1971 and the floatation of

major currencies, the conduct of exchange rate policy posed a serious challenge to allcentral banks world wide as currency fluctuations opened up tremendous opportunitiesfor market players to trade in currencies in a borderless market.

In December 1971, It was around this time that banks in India became interested intrading in foreign exchange.

HISTORICAL

PERSPECTIVE


15/70

Formative Stage: 1978-1992The impetus to trading in the foreign exchange market in India came in 1978 when

banks in India were allowed by the Reserve Bank to undertake intra-day trading inforeign exchange and were required to comply with the stipulation of maintainingsquare or near square position only at the close of business hours each day.

The extent of position which could be left uncovered overnight (the open position) as

well as the limits up to which dealers could trade during the day were to be decided bythe management of banks.The exchange rate of the rupee during this period was officially determined by the

Reserve Bank in terms of a weighted basket of currencies of Indias major tradingpartners and the exchange rate regime was characterized by daily announcement bythe Reserve Bank of its buying and selling rates to the Authorized Dealers (Ads) forundertaking merchant transactions. Authorized Dealers were also permitted to trade in

cross currencies (one convertible foreign currency versus another).

HISTORICAL

PERSPECTIVE


16/70

Formative Stage: 1978-1992The foreign exchange market in India till the early 1990s, however,

remained highly regulated with restrictions on external transactions,barriers to entry, low liquidity and high transaction costs. The exchangerate during this period was managed mainly for facilitating Indiasimports. The strict control on foreign exchange transactions through

the Foreign Exchange Regulations Act (FERA) had resulted in one of thelargest and most efficient parallel markets for foreign exchange in theworld, i.e., the hawala (unofficial) market.

By the late 1980s and the early 1990s, it was recognised that bothmacroeconomic policy and structural factors had contributed tobalance of payments difficulties. Devaluations by Indias competitorshad aggravated the situation. Although exports had recorded a highergrowth during the second half of the 1980s ( 4.3 per cent of GDP in1987-88 to about 5.8 per cent of GDP in 1990-91), trade imbalancespersisted at around 3 per cent of GDP. This combined with aprecipitous fall in invisible receipts in the form of private remittances,

travel and tourism earnings in the year 1990-91 led to further wideningofcurrent account deficit.

HISTORICAL

PERSPECTIVE


17/70

Post-Reform Period: 1992 onwardsIn July 1991 the massive drawdown in the foreign exchange reserves

Stopped the pegged exchange rate system & stared two-step adjustment ofexchange rate in July 1991 done to instill confidence among investors and toimprove domestic competitiveness.The Report of the High Level Committee on Balance of Payments (Chairman: Dr. C.

Rangarajan). Following the recommendations of the Committee to move towards the

market-determined exchange rate, the Liberalized Exchange Rate Management System(LERMS) was put in place in March 1992 initially involving a dual exchange ratesystem. Under the LERMS, all foreign exchange receipts on current accounttransactions (exports, remittances, etc.) were required to be surrendered to theAuthorized Dealers (ADs) in full. The rate of exchange for conversion of60 per cent ofthe proceeds of these transactions was the market rate quoted by the ADs, while theremaining 40 per cent of the proceeds were converted at the Reserve Banks official

rate. The ADs, in turn, were required to surrender these 40 per cent of theirpurchase of foreign currencies to the Reserve Bank. They were free to retain thebalance 60 per cent of foreign exchange for selling in the free market for permissibletransactions. The LERMS was essentially a transitional mechanism and a downwardadjustment in the official exchange rate took place in early December 1992 and ultimateconvergence of the dual rates was made effective from March 1, 1993, leading to theintroduction of a market-determined exchange rate regime.

HISTORICALPERSPECTIVE


18/70

Post-Reform Period: 1992 onwards

The dual exchange rate system was replaced by a unified exchangerate system in March 1993, whereby all foreign exchange receipts couldbe converted at market determined exchange rates. Therestrictions on a number of other current account transactions were

relaxed. With the rupee becoming fully convertible on all currentaccount transactions, the risk-bearing capacity of banks increased andforeign exchange trading volumes started rising.

This was supplemented by wide-ranging reforms undertaken by theReserve Bank in conjunction with the Government to remove marketdistortions and deepen the foreign exchange market.

The reform phase began with the Sodhani Committee (1994) madeseveral recommendations to relax the regulations with a view tovitalizing the foreign exchange market



19/70


20/70

Currency's value is matched to the value of another single currency or toa basket of other currencies, or to another measure of value, such as gold

It is a rate that the central bank sets and maintains as the officialexchange rate.

To maintain exchangerate, the central bankbuys and sells its owncurrency on the foreignexchange market in

return for the currency


21/70

If, for example, it is determined that the valueof a single unit of local currency is equal toUS$3, the central bank will have to ensure that

it can supply the market with those dollars. Inorder to maintain the rate, the central bankmust keep a high level of foreign reserves.

However, if the country persistently runsdeficits in the BOP, the central bank eventuallyruns out of foreign currencies, and will not beable to carry out the interventions


22/70

To maintain exchange rate, thecentral bank buys and sells its owncurrency on the foreign exchange

market in return for the currency towhich it is pegged.

However, if the country

persistently runs deficits in the BOP,the central bank eventually runs outof foreign currencies, and will not beable to carry out the interventions


23/70

Stabilizes the value of a currency

Makes trade and investments between thetwo countries easier and predictable

Means to control inflation

Helps keep businesses competitive inforeign markets


24/70

Heavy burden on exchange reserve

Country must have sufficient reserve

Fails to solve the balance of paymentdisequilibrium

It is not a long term solution if theunderlying economy is weak.

International disagreement might becreated when a country sets its exchangerate on a too low level

Fixing the exchange rate is not easy


25/70

The rate is determined by the private marketthrough supply and demand.

It is in effect since 1973

Clean floating the central bank stands aside

completely and allows the exchange rate to befreely determined in the forex market officialreserve transactions are zero

Managed floating-the central bank intervenesto buy or sell foreign currencies periodically in an

attempt to influence the exchange rates


26/70

Simple operation, smoother, morefluid adjustment

Brings realism in forex transactions Disequilibrium in balance of payment

is auto stabilized

No need to maintain large forexreserve


27/70

Tends to create uncertainty on theinternational markets.

Encourages inflation Floating exchange rates are affected

by more factors than only demandand supply, such as government

intervention Adverse effect of speculation


28/70

Demand and supply for foreignexchange

CHANGES IN EXCHANGE


29/70

EXCHAN

GERATE(RS.

FOR

$1)

CHANGES IN EXCHANGERATE IN FREE MARKET


30/70

Balance of trade and investmentPoliticsOther Countries

Economic TheoryInterest RateConsumersHousing

Industrial and Economic IndicatorCapital MarketEconomyInflation


31/70

More import and less export

Less Import and more export

Balance of investment

Budget deficit and national

debt

Presidents popularity

Terrorist attacks and war


32/70

FACTORS THAT DETERMINES/

AFFECTS EXCHANGE RATEBalance of trade and investmentPoliticsOther Countries

Economic TheoryInterest RateConsumersHousingIndustrial and Economic IndicatorCapital MarketEconomy

Inflation


33/70

BALANCE OF TRADE AND

INVESTMENTMore import and less export

Less Import and more export

Balance of investmentPOLITICS

Budget deficit and national

debt

Presidents popularity

Terrorist attacks and war

OTHER COUNTRIES


34/70

OTHER COUNTRIES

Turmoil in other countries

A change in foreign reserves

Acceptance of commodities in

dollars

Strong foreign economiesECONOMIC THEORY

Demand for currency

Increase in money supply


35/70

INTEREST RATES

CONSUMER BEHAVIORSavings

Spending

HOUSING

Slow housing market

Overinflated housing market

INFLATION RATE

INDUSTRY AND ECONOMIC


36/70

INDUSTRY AND ECONOMICINDICATORS

Growth in Mfg/ Employment

Outsourcing

Entrepreneurship

CAPITAL MARKET

Bear marketsBull markets

Accounting scandals


37/70

CONOMY

Economic growth and stability

Economic recession

Outperforming other economies


38/70


39/70

Current Account Convertibility: Convertibility required in thecase of transactions relating to exchange of goods and services,money transfers, income and current transfers and all thosetransactions are classified as Current Account Convertibility

E.g.: If an Indian citizen needs foreign exchange of smalleramounts, say $1,000, for going abroad or for educational purposes,she/he can obtain the same from a bank or a money-changer. This isa current account transaction

Capital Account convertibility: A capital account refers tocapital transfers and acquisition or disposal of non-produced, non-financial assets

E.g.: Suppose, one wants to import plant and machinery or investabroad, and needs a large amount of foreign exchange, say $2million, the importer will have to first obtain the permission of theReserve Bank of India (RBI). If approved, this becomes a capitalaccount transaction


40/70

Capital Account Convertibility(CAC) was first coined as a theoryby the Reserve Bank of India in 1997

by the Tarapore Committee.Objective: to find a fiscal and

economic policy that would enabledeveloping Third World countriestransition to globalized marketeconomies.


41/70

Capital Account Convertibility (CAC) means thefreedom to convert local financial assets into foreignfinancial assets and vice versa at market determinedrates of exchange.

Capital Account Convertibility allows anyone to freelymove from local currency into foreign currency andback.

It refers to the removal of restraints on internationalflows on a country's capital account, enabling fullcurrency convertibility and opening of the financialsystem.


42/70

Ensure total financial mobility in the country Efficient appropriation or distribution of international capital

in India and also helps in attracting foreign investment Enables foreign investors to re-convert local currency into

foreign currency anytime they want to and take their moneyaway.

Helps domestic companies to tap foreign markets. Greater access for resident companies to foreign capital and

debt markets reduce cost of capital


43/70

One has to operate within the limits specifiedby the reserve bank of India and obtainpermission from RBI for anything concerningforeign currency

With the advent of capital accountconvertibility, one would be able to lookforward to more and better goods and

services

Help NRIs remove all shackles on movementof their funds


44/70

CAC has 5 basic statements designed as points ofaction:

1. All types of liquid capital assets must be able to beexchanged freely, between any two nations, withstandardized exchange rates.

2.The amounts must be a significant amount (in excessof $500,000).

3. Capital inflows should be invested in semi-liquidassets, to prevent churning and excessive outflow.

4. Institutional investors should not use CAC tomanipulate fiscal policy or exchange rates.

5. Excessive inflows and outflows should be buffered bynational banks to provide collateral.


45/70

It allows domestic residents to invest abroad andhave a globally diversified investment portfolio,this reduces risk and stabilizes the economy..

Our NRI Diaspora will benefit tremendously if andwhen CAC becomes a reality. The reason is onaccount of current restrictions imposed onmovement of their funds. As the remittancesmade by NRIs are subject to numerousrestrictions which will be eased considerablyonce CAC is incorporated.

It also opens the gate for international savings tobe invested in India. It is good for India ifforeigners invest in Indian assets this makes

more capital available for Indias development.


46/70

Huge amounts of capital are moving across the border anyway. Itis better for India if these transactions happen in white money.Convertibility would reduce the size of the black economy, andimprove law and order, tax compliance and corporate governance.

Most importantly convertibility induces competition against Indian

finance. Currently, finance is a monopoly in mobilizing the savingsof Indian households for the investment plans of Indian firms. Nomatter how inefficient Indian finance is, households and firms donot have an alternative, thanks to capital controls.

As trade liberalization has consequently led to lower prices andsuperior quality of goods produced in India, capital account

liberalization will improve the quality and drop the price offinancial intermediation in India.


47/70

Good economy leads to huge inflows of foreign capital, but badeconomy will lead to an enormous outflow of capital under herdbehavior . For example, the South East Asian crisis.

Possibility of misallocation of capital inflows. E.g. capital inflows mayfund low-quality domestic investments, like investments in the stockmarkets or real estates, and desist from investing in building upindustries and factories, which leads to more capacity creation and

utilization, and increased level of employment. An open capital account can lead to the export of domestic savings

(the rich can convert their savings into dollars or pounds in foreignbanks or even assets in foreign countries), which for capital scarcedeveloping countries would curb domestic investment. Moreover,under the threat of a crisis, the domestic savings too might leave thecountry along with the foreign investments, thereby rendering the

government helpless to counter the threat.


48/70

International finance capital today ishighly volatile, i.e. it shifts from countryto country in search of higher speculativereturns. In this process, it has led toeconomic crisis in numerous developingcountries. Such finance capital is referredto as hot money in todays context. Fullcapital account convertibility exposes an

economy to extreme volatility on accountof hot money flows.


49/70

The Indian economy has the competence of bearing thestrains of free capital mobility given its fantastic growthrate and investor confidence.

The FOREX reserves provide enough buffer to bear theimmediate flight of capital which although seems unlikelygiven the macroeconomic variables of the economyalongside the confidence that international investors haveleveraged on India.

However it must not be forgotten that CAC is a big stepand integrates the economy with the global economycompletely thereby subjecting it to internationalfluctuations and business cycles.


50/70

There are restrictions on either residents orforeigners converting currency fortransactions but no ban on at least one sideresorting to such conversion.

there are ceilings on the amount of foreignexchange that can be purchased byresidents or firms registered in the countryfor acquisition of assets abroad.

Rupee is not convertible for all transactions

on capital account or inflows and outflows ofcapital.Also known as external convertibility.


51/70

In March 1992, under dual exchange ratesystem, 60% of all the receipts foreignexchange were exchanged at the marketrate, remaining 40% of the receipts wereconverted at the official rate of exchange.

It is available for some transactions likefor goods, services, capital movements,some selected items of goods, services

and capital. Restrictions on the amounts of the

currencies that can be exchanged.

It is applicable for the transactions on


52/70

Controls on capital movementsinclude prohibitions

Reduces the uncertainty ofoutflow of foreign funds withshort term maturity .


53/70

It is extent to which a country'sregulations allow free flow of moneyinto and outside the country

After liberalization in 1991, thegovernment eased the movement offoreign currency on trade account.

I.e. exporters and importers wereallowed to buy and sell foreigncurrency

Ability to exchange money for other currencies or for


54/70

b y o e c a ge o ey o o e cu e c es o ogold without government restriction. There is no ban either on residents converting rupeesinto foreign exchange or on foreigners converting

foreign exchange into rupees for investment purpose.Under FEMA Regulations, resident corporates havebeen allowed to invest overseas up to 100 % of theirnet worth or $100 million in an overseas joint venture

or wholly owned subsidiaryIn 2000, the forex policy allowed Indians to openaccounts abroad and transfer into them up to $25,000 a year.


55/70


56/70

May not lead to a new "equilibrium"in terms of the distribution ofdomestic wealth-holding betweendomestic and foreign assets


57/70

There are restrictions on either residents orforeigners converting currency fortransactions but no ban on at least one side

resorting to such conversion.There are ceilings on the amount of foreign

exchange that can be purchased by residentsor firms registered in the country for

acquisition of assets abroad.


58/70


59/70


60/70

The Bretton Woods Agreement of 1944 fixedthe conversion rate for one troy ounce of goldat $35.

August 1971 - United States President RichardNixon takes the dollar off the 'gold standard

March 1973 - Most major countries adopt

floating exchange rate system. US devaluesdollar to $42.2 per ounce. January 1980 - Gold hits record high at $850

per ounce. High inflation because of strong oilprices, Soviet intervention in Afghanistan andthe impact of the Iranian revolution, promptsinvestors to move into the metal.

August 1999 - Gold falls to a low at $251.70on worries about central banks reducingreserves of gold bullion and miningcompanies selling gold in forward markets toprotect against falling prices.


61/70

Oct 6 - Gold hits a record high of $1,035.95 an ouncein Europe, with buying fuelled by dollar weakness.

Oct 8 - Spot gold tops $1,050 per ounce, as thedollar's continued struggle makes the precious metalmore attractive to investors.

Nov 4 - Gold surges to 1,097.25 an ounce, a recordfor a second straight day, as the dollar drops broadlyafter the Federal Reserve says it intends to keep

interest rates low for some time.

Feb 20, 2009 - US gold futures

rise back above $1,000 an ounceto a peak of $1,005.40 asinvestors turn to gold as major

economies face recession andequity markets tumble.


62/70

THIS

YEAR


63/70

In 1991, India pawned 67 tons of gold to tideover a balance of payments crisis.

18 years later, the Reserve Bank of India hasbought thrice that amount of gold from the

IMF to diversify its assets.

In other words, it is ahedge against a falling

dollar.The exchange rate ofthe dollar against therupee will decline as


64/70

Dubai world a holding firm had taken loansto build real estate tourism ventures etc.

They are not able to repay the interest. For the first time in almost 10 years is a

country defaulting.

Since Dirham is pegged to the dollarforeign investments are affected.

This will result in the dollar becomingweaker, gold rising further and the Rupee

becoming stronger.


65/70

SDRs (Special Drawing Rights) aredefined in terms of a basket of majorcurrencies used in international trade andfinance.

SDRs were originally created to replaceGold and Silver in large internationaltransactions.

So called Paper Gold, eliminates thelogistical and security problems of

shipping gold back and forth acrossborders to settle national accounts.

The Dollar, Euro and Pound are contained in the SDRthese

currencies have been losing value to secondary reservecurrencies.

The SDR does not contain the Yuan, Rupee, Australian Dollarand Canadian Dollar which are important secondary reservecurrencies.


66/70

Dec 022009

Dec 012009

Nov 302009

Nov 292009

Euro 0.93600900

0.93560700

0.93300000

0.93028300

Pound 1.03476000

1.02809000

1.02305000

1.02108000

Dollar 0.6202840

0

0.6202840

0

0.6210480

0

0.6235980

0Yuan 0.0909149

00.09096670

0.09134420

0.09089980

Rupee 0.01336220

0.01336160

0.01332190

0.01341160

The International Monetary Fund allocated about $4.78 billion as itsshare from Special Drawing Rights (SDR) fund to India for providingliquidity to the recession hit global economic system.Out of IMFs 186 member countries, emerging markets and

developing countries would get over $18 billion out of the $100 billionallocated.


67/70

The recent G20 summit in London raised a fewquestions about the SDR.

Russia and China suggested that the Dollar bereplaced with SDR as the new reserve currency.

The countries under this proposal could converttheir reserves from dollars to SDRs without any

erosion in their value.


68/70

The dollar continues to dominate globalcurrency reserves nearly 64 per cent,against 27 per cent held in Euros.

OPEC countries prefer to price allpetroleum products only in the US dollar.

Many of the worlds currencies are peggedagainst the dollar.

Some countries have dispensed with theirown currencies and adopted the US dollaras their currency

Dr. Manmohan Singh :As far as I cansee right now, there is no substitutefor the dollar.

China holds about $2.5 trillion of reserve assets andhave not disposed of even a fraction of them. This

shows their confidence in the US dollar.


69/70

FCA 241,426GOLD Physical stock has

remained unchanged atapproximately 357 tonnes.

Forex Reserves 981 251,985

THANK


70/70

THANK

YOU

indian exchange rate policy

Documents