foreign exchange rate and policies

8/6/2019 Foreign Exchange Rate and Policies

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ForeignExchange Rate

Policies in India


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Contents

Meaning of Foreign Exchange Rate

BOP and Forex

Terms

Fixed exchange rate

Flexible Exchange rate

Evolution of Forex

Exchange rate policy

Indias Exchange rate policy- Chronology


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Meaning of Exchange rate A rate at which the currency of one country is

converted into another currency is called ExchangeRate or Nominal Exchange Rate(NER).

Real Exchange Rates:- The rate at which the goodsand services of one country is traded for the goodsand services of another country.

Real Exchange rate= NER * Domestic PriceForeign Price


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Balance of Payment and

Exchange Rate Balance of Payment the record of all

transactions of the residents with the rest of theworld

Trade balance Balance of exports and importsof goods exports are positive and imports arenegative

Current account balance Balance of trade ingoods, (trade balance), trade in services andtransfer payments


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Balance in services includes freight, royalty payments,

interest payments, dividend from assets abroad Transfer payments include remittances, gifts and grants

Capital account balance purchaseand sale of assets stocks, bonds, land purchase by Indians of assets

abroad is negative, purchase of assets by foreigners inIndia (e.g., FDI) are positive

Current account + Capital account = 0

Increase in official reserves is called overall BOP surplus


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Devaluation the price of foreign currencies under a fixedexchange rate regime is increased by official action

Revaluation - the price of foreign currencies under a fixedexchange rate regime is decreased by official action

Depreciation under a floating rate system, price of foreigncurrencies decreases because of market adjustment

Appreciation - under a floating rate system, price of foreigncurrencies decreases because of market adjustment

Terms


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In a fixed exchange rate system foreign centralbanks buy and sell their currencies at a fixed price interms of the domestic currency

Prior to 1973, most countries had fixed exchange rates

against each otherA fixed exchange rate acts like a price support system

In order to maintain a fixed exchange rate, the centralbank has to make up for the excess demand or take up

the the excess supply of foreign currency.

Fixed Exchange Rate


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Flexible Exchange Rate

In a flexible exchange rate system, the centralbank allows the exchange rate to adjust toequate thesupply and demand for foreign currency. In effectsince 1973

Clean floating the central bank stands asidecompletely and allows the exchange rate to be freelydetermined in the forex market official reservetransactions are zero

Managed float - the central bank intervenes to buyor sell foreign currencies periodically in an attempt toinfluence the exchange rates


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Foreign Exchange MarketIn India, the Foreign Exchange Market is a three-

level structure consisting of

(a)Reserve Bank of India(RBI) at the top

(b) Authorised Dealers licensed by RBI

(c) Customers (exporters, importers, companies andother exchange earners).

The authorised dealers are governed by theguidelines framed by the Foreign ExchangeDealers Association of India(FEDAI).


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Evolution of Foreign Exchange

PRE INDEPENDENCE:

Exchange control was implemented in India onSeptember 3, 1939.

The objective was mainly to regulate demand forforeign exchange for various purposes, within thelimit set by the available supply.

It lacked depth and liquidity.


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POST INDEPENDENCE:

FERA (Foreign Exchange Regulation

Act),1947: Enacted by British regime as a temporary measure.

The limited objective: To regulate the inflow of foreigncapital.

During this period the exports was not picking upwhile imports were high.

The foreign exchange policy during the 1950s was tomanage the exchange rate mainly for facilitating

Indias imports.


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The Bretton Woods System(1946-1971)

Member countries need to fix the parities of theircurrencies in terms US dollars or gold.

The countries were obliged to keep fluctuations in

their currency within +/- 1% of the declared parity. IMFs approval required to devaluate the currency.

US $35= an ounce of gold


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Collapse of Bretton Woods System

Persistent and very high American balance ofpayments deficit.

High inflation rate in USA in 1970-71

Market perception-Insufficient gold reservesby USA to massive supply of US dollars

US announced on 15 august, 1971 not toconvert US $ into gold at the fixed rate as

committed to IMF


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FERA(Foreign Exchange Regulation

Act0,1973:

Government of India reviewed FERA, 1947 forconserving foreign exchange rather thanregulating the entry of foreign capital.

As a crisis-driven legislation, the FERA,1973naturally contained several draconianprovisions. Any offence under FERA was a

criminal offence liable to imprisonment.


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Foreign Exchange Management

Act(FEMA),1999: The main objective: To facilitate external trade

and payments and promote the orderlydevelopment and maintenance of the foreignexchange market in India.

Law violators are treated as civil offenders rather

than criminals.


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Foreign exchange policy initiatives since

1991

From the Floating system under which theexchange rate was officially determined theregime has passed through several phrases toreach the present Market- based system underwhich Exchange rate is determined by forces ofdemand and supply.


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Introduction of (LERMS),1992.

LERMS Liberalized Exchange RateManagement System , partial convertibility ofthe rupee was introduced in the form of a dualexchange rate system

The rate of exchange for conversion of 60% ofthe proceeds of the transactions was themarket rate quoted by the Ads whileremaining 40% of the proceeds were

converted at the RBIs official rate.


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Exchange Rate Policy

Synchronization If policies are not synchronized between countries, they

may pose a major threat to free trade

When import prices fall due to currency appreciation, largeshifts in demand will occur domestic workers become

unemployed leads to pressure for protection tariff andquotas

Flexible exchange regime calls for more interdependencethan fixed exchange rate.

Through international coordination of interests and policies,the system works better

Regular consultation between major currencies


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Exchange rate of rupee with US $


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Indias Exchange rate policy-Chronology

Year

1947: Rupee tied to pound. Rs 1= 1s

18 September,

1949

Pound devalued; India maintained par with pound

6 June, 1966 Rupee is devalued, Rs 4.76 = $1, after devaluation, Rs7.50 = $1 (57.5%)

18 November,

1967

UK devalued pound, India did not devalue

August 1971 Rupee pegged to gold/dollar, international financial crisis


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Conti

18 December,1971 Dollar is devalued

20 December,1971

Rupee is pegged to pound sterling again

1971-1979 The Rupee is overvalued due to Indias policy of importsubstitution

23 June, 1972 UK floats pound, India maintains fixed exchange rate withpound

1975 India links rupee with basket of currencies of major tradingpartners. Although the basket is periodically altered, the linkis maintained until the 1991 devaluation.

July 1991 Rupee devalued by 18-19 %


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March 1992 Dual exchange rate, LERMS, Liberalized Exchange Rate

Management System

March 1993 Unified exchange rate: $1 = Rs 31.37

1993/1994 Rupee is made freely convertible for trading, but not forinvestment purposes


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References

Economic survey of India: 1947-48 to 2008-09 byDr. Chandra Shekhar Prasad.

Sixty years of Indian economy:1947 to 2007

Indian Currency system CMIE(Centre for Monitoring Indian Economy)

www.economypedia.com

Seniors
http://www.economypedia.com/http://www.economypedia.com/


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foreign exchange rate and policies

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