Foreign Exchange Rate Management in India
The exchange rate denotes the value of a particular currency in terms of another currency, and exchange rate management is a set of policies that determine the exchange rate of foreign currency in the market.
Foreign Exchange Market deals with foreign currencies that are bought and sold in India. Here are more details about the foreign exchange rate management systems in India.
Functions of Foreign Exchange Market:
The following are the functions of the foreign exchange market:
- Currency transfer from one market to another as per the transaction requirement
- Foreign exchange rate stabilisation through forward and spot market
- Hedge the foreign exchange risk caused due to the fluctuation in the exchange rates
- Facilitating the smooth flow of goods and services between various countries by providing short-term credits to importers.
Features of Foreign Exchange Market
Here are the significant features of the foreign exchange market:
- Provides market transparency by offering full access to market data and information
- Easily liquefiable financial market worldwide
- Dynamic market where currency values change every second and hour
- Operates 24 hours a day
Background history
The exchange rate management system has evolved over the years in India. Here is the list of evolution of exchange management system in India since Independence till today:
- Par Value System (1947-1971): In this system of the International Monetary Fund (IMF), the external par value of rupee was fixed at 4.15 grains of fine gold.
- Pegged Regime (1971-1992): Indian currency pegged to US Dollar and the pound sterling in from August 1971 to December 1991 and from December 1971 to September 1975, respectively.
- The Period Since 1991: In 1 and 3 July 1991, exchange rate of Indian currency went through two-step downward adjustment by 18% to 19%.
- Liberalised Exchange Rate Management System: Liberalised exchange rate management system (LERMS) was announced in the budget for 1992- 1993 that introduced partial convertibility of rupee. In this system, a dual exchange rate was fixed in which 40% to be surrendered to the official exchange rate and the remaining 60% converted at a market-determined rate.
Types of Foreign Exchange Market in India
FOREX, also known as Foreign Exchange Market, is the world’s largest marketplace for trading in currencies. Here are the types of Foreign Exchange Market in
The exchange rate denotes the value of a particular currency in terms of another currency, and exchange rate management is a set of policies that determine the exchange rate of foreign currency in the market. Foreign Exchange Market deals with foreign currencies that are bought and sold in India. Here are more details about the foreign exchange rate management systems in India.
- Spot Market: In this market, transactions involve currency pairs. The market is not exposed to market fluctuations and as a result, the transaction takes place at the prevailing spot rate without any sudden increase or decrease in price.
- Futures Market: In this market system, future payment takes place at the previously agreed exchange rate. The terms are set beforehand and cannot be altered. This offers consistent return on assets to the traders who perform the majority of transactions on the futures market.
- Forward Market: In this market system, the terms are negotiable and either of the parties can alter the terms as per their needs. This is way more flexible than other forms of foreign exchange markets in India.
- Swap Market: Borrowing and lending of two types of currencies take place between the investors in this market system. One investor borrows in one currency and pays off the other investor in the second currency. This market allows investors to pay off their obligations without dealing with foreign exchange risk.
- Option Market: In this system, investors can perform currency exchange from one denomination to another at a specific rate and on a particular date.
Types of Exchange Rate Management in India
Here are the types of exchange rate management in India:
- Fixed Exchange Rate Management: Under the IMF system, the monetary authority of a country fixes the exchange rate between the domestic and foreign currencies which cannot be altered beyond a limit. The official value of the currency of the member nation is fixed in terms of reserve currency or a basket of 'key currencies’. This is also known as the 'pegged' exchange rate where flexibility as prescribed by IMF is 1% up and down under normal conditions.
- Flexible or Floating Exchange Rate Management: Free floating or flexible exchange rate management system determines the exchange rate as per the market force. The intervention of monetary authorities is not allowed under this system. Under this system, rates may fluctuate anytime and as a result, the rates are determined daily without any restrictions imposed by governmental policy.
Advantages and Disadvantages of the Different types of Exchange Rate Management in India
Below is the list of advantages and disadvantages of fixed and floating exchange rate management systems in India:
| Advantages | Disadvantages |
Fixed Exchange Rate Management |
|
|
Flexible or Floating Exchange Rate Management |
|
|
FAQs on Foreign Exchange Rate Management
- Who participates in the foreign exchange market?
The participants in the foreign exchange market are the Central Bank, Commercial Banks, traditional users (foreign tourists), brokers, traders and speculators.
- Who maintains the exchange rate in India?
The Reserve Bank of India (RBI) maintains the exchange rate in India. RBI is the custodian of India’s foreign exchange reserve and manages the foreign investment of the country.
- How does the government control exchange rates?
The government, through its Central Bank, determines the fixed or pegged rate. This is done by setting a rate against the major world currencies such as US Dollar, Euro, or Yen. Now, the government will buy or sell its own currency against the pegged currency to maintain its exchange rate.
- What is the need of exchange control regulations in India?
Exchange control regulations in India is needed to facilitate external trade and payments, encourage organised development, maintenance of the foreign exchange market in India and to liberalize the economic policies.
- What factors affect exchange rates?
The factors that affect exchange rates are inflation rates, interest rates, recession, balance of payments, government debt, terms of trade, and political stability and economic performance.
- What makes a good exchange rate?
Increase in interest rates and trade creates good exchange rates. A high demand for a country's currency and improving economic health of a country is also creates a favorable exchange rate.
- What is the formula for calculating exchange rates?
The formula for calculating the exchange rates is: Starting Amount (Original Currency) / Ending Amount (New Currency) = Exchange Rate
- Is there a limit on foreign currency exchange?
No, there is no maximum limit on foreign currency exchange. Individuals can exchange any amount of foreign currency each day.
- Where can I exchange foreign currency for free?
There are some banks such as U.S. Banks that offer foreign currency exchange without involving any processing free. In some cases, there may be some stipulations in which orders above a certain amount can only be done free of cost. In such a case, contact the bank for detailed information about their foreign currency exchange norms.
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