FOREIGN EXCHANGE MANAGEMENT ACT

NO PERSON SHALL DEAL IN OR TRANSFER FOREIGN EXCHANGE OR

FOREIGN SECURITY TO ANY PERSON NOT BEING AN AUTHORISED
PERSON.

NO PERSON (RESIDENT IN INDIA) SHALL ACQUIRE, HOLD, OWN, POSSESS

OR TRANSFER ANY FOREIGN EXCHANGE, FOREIGN SECURITY OR ANY
IMMOVABLE PROPERTY SITUATED OUTSIDE INDIA, SAVE AS OTHERWISE
PROVIDED IN THIS ACT.

ANY PERSON MAY SELL OR DRAW FOREIGN EXCHANGE TO OR FROM AN

AUTHORISED PERSON IF SUCH SALE OR WITHDRAWAL IS A CURRENT
ACCOUNT TRANSACTION PROVIDED THAT THE CENTRAL GOVT. MAY IN
PUBLIC INTEREST AND IN CONSULTATION WITH RBI, IMPOSE SUCH
REASONABLE RESTRICTIONS.
ENTER INTO ANY FINANCIAL TRANSACTION IN INDIA AS CONSIDERATION
FOR ON IN ASSOCIATION WITH ACQUISITION OR CREATION OR TRANSFER
OF A RIGHT TO ACQUIRE, ANY ASSET OUTSIDE INDIA BY ANY PERSON
 MANAGEMENT OF FOREIGN EXCHANGE RESERVES
(FOREX)

• MAINTAINING BALANCE IN MONETARY AND EXCHANGE RATE

POLICIES.

• ENHANCING THE CAPACITY TO INTERVENE IN FOREX MARKETS.

• LIMITING EXTERNAL VULNERABILITY SO AS TO ABSORB SHOCKS

DURING TIMES OF CRISIS.

• PROVIDING CONFIDENDE TO THE MARKETS THAT EXTERNAL

OBLIGATIONS CAN ALWAYS BE CONSIDERED.

• ADDING TO THE COMFORT OF THE MARKET PARTICIPANTS BY

DEMONSTRATING THE BACKING OF DOMESTIC CURRENCY BY
EXTERNAL ASSETS
 INSTRUMENTS OF FOREIGN EXCHANGE

• SPOT RATE IS THE EXCHANGE RATE QUOTED FOR TRANSACTIONS THAT

REQUIRE EITHER IMMEDIATE DELIVERY OR WITHIN TWO DAYS. THE RATE AT
WHICH THE TRANSACTIONS IS SETTLED IS THE SPOT RATE.

• OUTRIGHT FORWARD THIS INVOLVES THE EXCHANGE OF CURRENCY

THREE OR MORE DAYS AFTER THE DATE. THE RATE AT WHICH THE
TRANSACTION IS SETTLED IS THE FORWARD RATE.
• FX SWAP THIS IS A SIMULTANEOUS SPOT AND FORWARD TRANSACTION

• CURRENCY SWAP DEALS MORE WITH INTEREST BEARING FINANCIAL

INSTRUMENTS (SUCH AS BOND) AND THEY INVOLVE THE EXCHANGE OF
PRINCIPAL AND INTEREST PAYMENTS.
• OPTIONS IS THE RIGHT BUT NOT THE OBLIGATION TO TRADE A FOREIGN
CURRENCY AT A SPECIFIC EXCHANGE RATE
• FUTURE CONTRACT THIS IS AN AGREEMENT BETWEEN TWO PARTIES TO
BUY OR SELL A PARTICULAR CURRENCY AT A PRICE ON A PARTICULAR
FUTURE DATE, AS SPECIFIED IN A STANDARD CONTRACT TO ALL
PARTICIPANTS IN THAT CURRENCY FUTURE EXCHANGE.
 INTERNATIONAL EXCHANGE RATES

NOMINAL EXCHANGE RATE REAL EXCHANGE RATE

THE RATE AT WHICH A THE RATE AT WHICH A

PERSON CAN PERSON CAN

TRADE THE CURRENCY OF TRADE THE GOODS AND

ONE SERVICES

COUNTRY FOR THE OF ONE COUNTRY FOR THE

CURRENCY OF GOODS

ANOTHER. AND SERVICES OF ANOTHER.

 Real Exchange Rate

Real exchange rate = Nominal exchange rate x Domestic price

Foreign Price
APPRECIATION DEPRECIATION

AN INCREASE IN THE VALUE A DECREASE IN THE VALUE

OF A CURRENCY AS OF A CURRENCY AS
MEASURED BY THE MEASURED BY THE
AMOUNT OF FOREIGN AMOUNT OF FOREIGN
CURRENCY IT CAN BUY CURRENCY IT CAN BUY.
 Determination of Exchange
Rate
PPP- Purchasing Power Parity.
ER = Er x Pd/Pf,

Where, ER= equilibrium exchange rate

Er= exchange rate in the reference period.
Pd= domestic price index
Pf= foreign country’s price index.
 Determination of exchange rate
International Fisher effect (IFE)
The country with higher nominal interest rate should
have higher inflation and hence that country’s
currency will weaken in future.

Nominal interest rate= real interest rate + inflation

 Balance of payment

Definition: Balance f Payment is a systematic record of all transactions

between the residents of the country and the rest of the world during
a given period.

Current Account: Transfer of real income.

Capital Account: Transfer of funds without effecting a shift in real

income.
 CURRENT ACCOUNT
Export and import of services, income on investments and unilateral
payments (gifts, remittances for family maintenance etc.)

a) Current Account Receipts:

Export of goods
Invisibles: Services, unilateral transfers, investment income
Non-Monetary movement of gold.

b) Current Account Payments:

Import of goods
Invisibles: Services, unilateral transfers, investment income
Non-Monetary movement of gold.

Current account surplus = X-M (Export-Import)

 CAPITAL ACCOUNT

a) Capital Account Receipts:

Long term inflow of funds
Short term inflow of funds

b) Capital Account Payments :

Long term outflow of funds
Short term outflow of funds
 Balance of Trade

Favorable balance of trade(surplus)= export > import

Unfavorable balance of trade (deficit) = import > export

 Need for Exchange control

• To save foreign exchange by importing the essential commodities

only and check the import of items considered wasteful.
• To maintain stability of exchange rates and to prevent violent
fluctuations there in.
• To control and conserve the supply of foreign exchange which is
scarce.
• To protect home industries from unfair competition by exporting
countries.
• To restrict the outflow of capital.
• To prevent export of essential goods and to encourage export of
surplus goods.
• To favour trade with particular countries and to discourage trade
with other countries
• To secure bargaining power in foreign trade and to assist in central
planning for economic development
 Objectives of exchange control

• To strengthen the government.

• To conserve foreign exchange.
• To check speculation .
• To check capital flight.
• To improve balance of payments.
• To protect domestic industries.
• To check recession- induced exports into the country.
• To maintain exchange rate stability.
• To enable government to repay foreign loans.
 Methods of Exchange control

1. Unilateral

2. Bilateral/ Multilateral
 UNILATERAL
• REGULATION OF BANK RATE
• REGULATION OF FOREIGN TRADE
• RATIONING OF FOREIGN EXCHANGE
• EXCHANGE PEGGING
• EXCHANGE EQUALISATION FUNDS
• BLOCKED FUNDS
 BILATERAL/MULTILATERAL

• PRIVATE COMPENSATION AGREEMENT

• CLEARING AGREEMENT

• STANDSTILL AGREEMENT

• PAYMENTS AGREEMENT