Exchange Rate Management in India:

India was among the original members of the IMF when it started” functioning in 1946. As such, India

was obliged to adopt the Bretton Woods system of exchange rate determination. This system is known as

the par value system of pegged exchange rate system. Under this system, each member country of the IMF

was required to define the value of its currency in terms of gold or the US dollar and maintain (or peg) the

market value of its currency within ± per cent of the defined (par) value.

The Bretton Woods system collapsed in 1971. Consequently, the rupee was pegged to pound sterling for

four years after which it was initially linked to the basket of 14 currencies but later reduced to 5 currencies

of India’s major trading partners.

An exchange-rate regime is the way an authority manages its currency in relation to other
currencies and the foreign exchange market. Between the two limits of fixed and freely floating
exchange regimes, there can be several other types of regimes. In their operational objective, it is
closely related to monetary policy of the country with both depending on common factors of
influence and impact.

The exchange rate regime has a big impact on world trade and financial flows. The volume of
such transactions and the speed at which they are growing makes the exchange rate regime a
central piece of any national economic policy framework.

Exchange Rate Reforms:

Exchange rate reforms have proceeded gradually beginning with a two- stage cumulative
devaluation of rupee by about 20 per cent effected in July 1991. Subsequently, the Liberalised
Exchange Rate Management System (LERMS) was introduced in 1992, which was later replaced
by the Unified Exchange Rate System (UERS) in 1993. The net result was an effective
devaluation of the rupee by around 35 per cent in nominal terms and 25 per cent in real terms
between July 1991 and March 1993.

Features of the Current Regime:

The principal features of the current exchange rate regime in India can be briefly stated as
follows:

i. The rates of exchange are determined in the market.

ii. The freely floating exchange rate regime continues to operate within the framework of
exchange control.

iii. Current receipts are surrendered (or deposited) to the banking system, which in turn, meets
the demand for foreign exchange.

iv. RBI can intervene in the market to modulate the volatility and sharp depreciation of the rupee.
It effects transactions at a rate of exchange, which could change within a margin of 5 per cent of
the prevailing market rate.

v. The US dollar is the principal currency for the RBI transactions.

vi. The RBI also announces a Reference Rate based on the quotations of select banks on Bombay
at twelve noon every day. The Reference Rate is applicable to SDR transactions and transactions
routed through the Asia Clearing Union.

In short, the India rupee has matured to a regime of the floating exchange rate from the earlier
versions of a ‘managed float’.

Convertibility on Current Account:

The current regime of the exchange rate has been accompanied by full ‘Convertibility on current
account with effect from August 20, 1994. Accordingly, several provisions like remittances for
service, education, basic travel, gift remittances, donation, and provisions of the Exchange
Earners’ Foreign Currency Account (EEFCA) were relaxed.

In a further move, announced in 1997, the RBI liberalised the existing regulations in regard to
payments for various kinds of feasibility studies, legal services, postal imports and purchases of
designs and drawings. With this, India acquired a status called as the IMF Article VIII Status.

By attaining the Article VIII status, India has reached a position by which it can instill
confidence among the international investor community, paving the way for further inflow of
foreign capital. Further, India is also committed to allowing free outflow of current account
payments (like interest) even if there is a serious foreign exchange crisis.

Notwithstanding the above, the government still retains many controls on current account.

Methodology:

Secondary Data:-short info of 3-4 lines

I chose secondary data because:-

1. It’s less time-consuming

2. More reliable and trustworthy than self-introspection

 3. Unbiased views

Intervention by RBI:

The current exchange rate regime, introduced in 1993, the RBI has been, actively intervening in
the foreign exchange market with the objective of maintaining the real effective exchange rate
(REER) stable.

The RBI uses two types of intervention in this regard:

i. Direct Intervention:

It refers to purchases and sales in international currency (i.e. US dollars and euro) both on the
spot and also in forward markets.

ii. Indirect Intervention:

It refers to the use of reserve requirements and interest rate flexibility to smoothen temporary
mismatches between demand and supply of foreign currency.

Intervention by the RBI has raised a question as to whether or not there should be an exchange
rate band within, which the central bank should allow the currency to fluctuate. The Tarapore
Committee in its report on Capital Account Convertibility had, while suggesting transparency in
the exchange rate policy of the central bank, recommended a band within which it would allow
the currency to move.

The RBI has been, in contrast, saying that there cannot be such rigidities in exchange rate policy,
and, therefore, the bank should have the right to intervene at its discretion. Such interventions are
considered necessary till the rupee is made fully convertible.

Forces Behind Exchange Rate Determination

Foreign Exchange is a price of one country currency in relation to other country currency, which
like the price of any other commodity is determined by the demand and supply factors. The
demand and supply of the foreign exchange rate come from the residents of the respective
countries.

Demand for Foreign Exchange (Foreign Money
goes out)
Foreign Currency is needed to carry out transactions
in foreign countries or for the purchase of foreign
goods and services (IMPORTS).
Foreign currency is needed to invest in foreign
country assets/shares/bonds etc.
Supply of Foreign Exchange (Foreign
Money Comes in)
The source of foreign currency available to
the domestic country are foreigners
purchasing our goods and services
(Exports).
Foreigners investing in Indian Stock
markets, Assets, Bonds etc. (FPIs and
FDIs)
Foreign currency is needed to make transfer Transfer payments. Example: Indian
payments. Example: Indian Parents sending Money to working in the USA, sending money to
his/her son/daughter studying in the USA. his/her old aged parents.
Indians holding money in overseas Banks Foreigners holding assets in Indian Banks.
Indians Travelling abroad for Tourism Purpose. Foreigners travelling to India.

 The DD curve represents the demand for foreign exchange by India. The SS curve
represents the supply of foreign exchange to India.

 The point where both DD and SS curves intersect is the point of equilibrium. At this point
demand for foreign exchange is exactly equal to the supply of foreign exchange.

 At equilibrium point E0, the exchange rate is 1 $ equal to 5 Re.

 In normal day to day functioning of markets, the exchange rate may fluctuate. If at any
point in time, the exchange rate is at E1, then the demand for foreign exchange falls short
of supply of foreign exchange, as a result at this point Indians are demanding less foreign
currency due to which Re will appreciate vis-à-vis foreign currency. The appreciation
mainly occurs due to a favorable balance of payment situation (Surplus).

 By the same token at point E2, demand for foreign exchange is greater than the supply of
foreign exchange, at this point Indians are demanding excess foreign exchange than what
the foreigners are willing to supply, as a result, at E2 Re will depreciate vis-à-vis foreign
currency. The depreciation mainly occurs due to the unfavorable balance of payments
situation(Deficits).
 Conclusion
The Foreign exchange monetary market is the biggest financial market in the world.

A floating exchange rate

 A fluctuating exchange rate is a type of exchange-rate regime in which a currency's value

is allowed to fluctuate in response to foreign-exchange market mechanisms. A currency
that uses a floating exchange rate is known as a floating currency.

Fixed Currency regime

 A floating currency is contrasted with a fixed currency whose value is tied to that of
another currency, gold or to a currency basket.

Managed Float Regime

 Managed float regime is the current international financial environment in which

exchange rates fluctuate from day to day, but central banks attempt to influence their
countries' exchange rates by buying and selling currencies. It is also known as a dirty
float.

Indian Scenario

India after a long history of trying various exchange rate systems like pegging with pound
sterling (immediately after independence ) then moving to bretton wood systems and the like
currently follows a managed float regime.

RBI manages floating of rupee by the following policy measures -

1. RBI controls foreign money flowing in and out of the country through different routes.

2. It also selectively engages in buying and selling of foreign currencies to mediate demand
and supply in the forex market.

Why India can't follow a fixed rate regime

Lack of enough forex reserves -

 India is not having a fixed rate economy because currently the forex reserves of RBI is
insufficient to fix the exchange rate of the country.The reason why big economies like
china once had a fixed exchange rate (now moving towards managed floating ) is because
they had sufficient foreign exchange reserves with them to manage the value of currency
 from fluctuating by means of buying and selling currency and due to it's large export
base.

the government (central bank) sets and maintains as the official exchange rate. A set price will be
determined against a major world currency (usually the U.S. dollar, but also other major currencies such
as the euro, the yen or a basket of currencies). In order to maintain the local exchange rate, the central
bank buys and sells its own currency on the foreign exchange market in return for the currency to which
it is pegged.
Eg. $1 = Rs.40 is the rate of the dollar against the Rupee in this case the RBI in order to maintain this rate
will sell/buy its forex reserves. This system has the following Cons:-

A common element with all fixed or pegged foreign exchange regimes is the need to maintain the fixed
exchange rate. This requires large amounts of reserves as the country's government or central bank is
constantly buying or selling the domestic currency. China is a perfect example. Before repealing the fixed
rate scheme in 2010, Chinese foreign exchange reserves grew significantly each year in order to maintain
the U.S. dollar peg rate. The pace of growth in reserves was so rapid it took China only a couple of years
to overshadow Japan's foreign exchange reserves. As of January 2011, it was announced that Beijing
owned $2.8 trillion in reserves – more than double that of Japan at the time.

The problem with huge currency reserves is that the massive amount of funds or capital that is being
created can create unwanted economic side effects – namely higher inflation. The more currency
reserves there are, the wider the monetary supply – causing prices to rise. Rising prices can cause havoc
for countries that are looking to keep things stable. As of December 2010, China's consumer price
inflation had moved to around 5%

On the other hand Floating Market Currency fluctuates with the International Market it helps in the
following ways :-

 Automatic balance of payments adjustment - Any balance of payments disequilibrium will tend
to be rectified by a change in the exchange rate. For example, if a country has a balance of
payments deficit then the currency should depreciate. This is because imports will be greater
than exports meaning the supply of sterling on the foreign exchanges will be increasing as
importers sell pounds to pay for the imports. This will drive the value of the pound down. The
effect of the depreciation should be to make your exports cheaper and imports more expensive,
thus increasing demand for your goods abroad and reducing demand for foreign goods in your
own country, therefore dealing with the balance of payments problem. Conversely, a balance of
payments surplus should be eliminated by an appreciation of the currency.

 Freeing internal policy - With a floating exchange rate, balance of payments disequilibrium
should be rectified by a change in the external price of the currency. However, with a fixed rate,
curing a deficit could involve a general deflationary policy resulting in unpleasant consequences
for the whole economy such as unemployment. The floating rate allows governments freedom
to pursue their own internal policy objectives such as growth and full employment without
external constraints.
  Absence of crises - Fixed rates are often characterised by crises as pressure mounts on a
currency to devalue or revalue. The fact that, with a floating rate, such changes are automatic
should remove the element of crisis from international relations.

 Flexibility - Post-1973 there were great changes in the pattern of world trade as well as a major
change in world economics as a result of the OPEC oil shock. A fixed exchange rate would have
caused major problems at this time as some countries would be uncompetitive given their
inflation rate. The floating rate allows a country to re-adjust more flexibly to external shocks.

 Lower foreign exchange reserves - A country with a fixed rate usually has to hold large amounts
of foreign currency in order to prepare for a time when they have to defend that fixed rate.
These reserves have an opportunity cost.

Objective of the Act

The main objective of FERA was conservation and proper utilization of the foreign exchange
resources of the country. It also sought to control certain aspects of the conduct of business
outside the country by Indian companies and in India by foreign companies.When a business
enterprise imports goods from other countries, exports its products to them or makes investments
abroad, it deals in foreign exchange. Foreign exchange means 'foreign currency' and includes
deposits, credits and balances payable in any foreign currency and secondly drafts, travelers,
cheques, letters of credit or bills of exchange, expressed or drawn in Indian currency but payable
in any foreign currency.

Conclusion

FEMA permits only authorized person to deal in foreign exchange or foreign security. Such an
authorized person, under the Act, means authorized dealer, money changer, off-shore banking
unit or any other person for the time being authorized by Reserve Bank. The Act thus prohibits
any person who deal in or transfer any foreign exchange or foreign security to any person not
being an authorized person. Make any payment to or for the credit of any person resident outside
India in any manner. Receive otherwise through an authorized person, any payment by order or
on behalf of any person resident outside India in any manner.

Enter into any financial transaction in India as consideration for or in association with acquisition
or creation or transfer of a right to acquire, any asset outside India by any person is resident in
India which acquires, hold, own, possess or transfer any foreign exchange, foreign security or
any immovable property situated outside India.

Main Features of FEMA Act

 Activities such as payments made to any person outside India or receipts from them,
along with the deals in foreign exchange and foreign security is restricted. It is FEMA
that gives the central government the power to impose the restrictions.
 Without general or specific permission of the MA restricts the transactions involving
foreign exchange or foreign security and payments from outside the country to India – the
transactions should be made only through an authorised person.

 Deals in foreign exchange under the current account by an authorised person can be
restricted by the Central Government, based on public interest generally.

 Although selling or drawing of foreign exchange is done through an authorized person,

the RBI is empowered by this Act to subject the capital account transactions to a number
of restrictions.

 Residents of India will be permitted to carry out transactions in foreign exchange, foreign
security or to own or hold immovable property abroad if the currency, security or
property was owned or acquired when he/she was living outside India, or when it was
inherited by him/her from someone living outside India.

Opinion:

Capital account convertibility [CAC] is a feature of a nation's financial template that

centers on the ability to conduct transactions of local financial assets into foreign
financial assets freely or at country determined exchange rates. In layman's terms, full
capital account convertibility allows local currency to be exchanged for foreign currency
without any restriction on the amount.

Domestic companies and individuals are concerned they also benefit from capital convertibility
because they also can invest in the foreign countries so if an individual wants to take advantage
of opportunities in foreign country due to fall in price of stock or real estate or other asset
classes in foreign countries then they can easily do it under capital convertibility regime and on
the other side domestic companies can also borrow funds from foreign countries if the rate of
interest is on the lower side.

31. 31 CONCLUSION The foreign monetary exchange market is the biggest financial market in the
world. Bigger than the New York Stock Exchange and Futures Market combined. And with
reduced "buy-in" limits now, even small-time players can join the Forex trading marketplace.
That doesn't mean everyone should join, however. Buying an auto-trading program sold to you
with the promise of making you millions probably won't. In fact, it may cost you everything you
own. The only way to win in Forex trading is the good, old-fashioned way - hard work
andasolidunderstandingofthemarket. One has to be clued in to global developments, trends in
world trade as well as economic indicators of different countries. These include GDP growth,
fiscal and monetary policies, inflows and outflows of the currency, local stock market
performance and interest rates. The currency derivatives market is highly leveraged. In the stock
futures market, a 20% margin gains a five-fold leverage. In forex futures, the margin payable is
just 3%, so the leverage is 33 times. This means that even a 1% change can wipe out a third of
the investment. However, the Indian currency markets are well-regulated and there is almost no
counter-party risk. Investors should start small and gradually invest more. One has to be clued in
to global developments, trends in world trade as well as economic indicators of different
countries. These include GDP growth, fiscal and monetary policies, inflows and outflows of the
currency, local stock market performance and interest rates.