Exchange rate management and control

Rohit Oberoi MBA 4th sem WFTM

1. IMS(international monetary system) 2. types of exchange rates 3. FERA/FEMA 4. Determination of foreign exchange rate-exchange control regulations and procedures in india.

Topics Covered

 The international monetary system refers to

the institutional arrangements that countries adopt to govern exchange rates.

Also called International monetary and Financial

System.

International monetary systems are sets of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between nation states

Objective of IMS
To contribute to stable and high global growth

Evolution of the International Monetary System

Bimetallism: Before 1875

A double standard in the sense that both gold and silver were used as money.

Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents.

Bimetallism: Before 1875

Great Britain: Until 1816 (law passed for free coinage on gold only) US: From 1792 (Coinage Act of 1792) till 1873 France: Since French Revolution till 1878

India, China, Germany, Holland were on silver standard

Due to wars and political unstability, US, Russia and Austria-Hungry had irredeemable currencies :1848-79 Not systematic IMS until 1870s

Bimetallism: Before 1875 Greshams Law

Phenomenon experienced by the countries that were on the bimettalic standard. Since exchange rate between two currency was fixed officially, only the abundant metal was used as money, driving more scarce metal out of circulation.

Greshams Law: Bad (abundant) money drives out Good (scarce) money

Classical Gold Standard: 1875-1914

Country Great Britain Germany Sweden, Norway and Denmark France, Belgium, Switzerland, Italy and Greece Netherlands Uruguay USA Austria Chile Japan Russia Dominican Republic Panama Mexico Year 1816 1871 1873 1874 1875 1876 1879 1892 1895 1897 1898 1901 1904 1905

Strong interest of every country to implement the same international monetary system as their most important economic and financial partners have implemented

Classical Gold Standard: 1875-1914

During this period in most major countries:
Gold alone was assured of unrestricted coinage There was two-way convertibility between gold and national currencies at a stable ratio. Gold could be freely exported or imported.

The exchange rate between two countrys currencies would be determined by their relative gold contents.

Classical Gold Standard: 1875-1914

For example, if the dollar is pegged to gold at U.S.$30 = 1 ounce of gold, and the British pound is pegged to gold at 6 = 1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents:
$30 = 6

$5 = 1

Classical Gold Standard: 1875-1914

Highly stable exchange rates under the classical gold standard provided an environment that was favorable to international trade and investment. Misalignment of exchange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism.

Price-Specie-Flow Mechanism
Suppose Great Britain exported more to France than France imported from Great Britain.
Net export of goods from Great Britain to France will be accompanied by a net flow of gold from France to Great Britain. This flow of gold will lead to a lower price level in France and, at the same time, a higher price level in Britain.

The resultant change in relative price levels will slow exports from Great Britain and encourage exports from France.

Classical Gold Standard: 1875-1914

There are shortcomings:
The supply of newly minted gold is so restricted that the growth of world trade and investment can be hampered for the lack of sufficient monetary reserves. Even if the world returned to a gold standard, any national government could abandon the standard.

The Interwar Experience

With the outbreak of World War I, the classical gold standard came to an end: extremely negative effects of the lack of agreement on the functioning of the international monetary system three trials of establishment:
exchange rate depended completely on the supply of and demand for foreign currency

Conference in Genoa (1922) negotiations in 1933 three-party agreement between the USA, Great Britain and France (1936)

1919 1926: Experience With Flexible Exchange Rates

entirely different economic and political circumstances at the end of World War I made quick return to stable economic circumstances realistically impossible flexible exchange rates were perceived as an exclusively temporary solution that needed to be replaced by a more permanent solution (going back to the prewar classical gold standard) as soon as possible

1919 1926: Experience With Flexible Exchange Rates

countries with hyperinflation and their return to the gold standard: high rate of inflation caused by printing of money, that was used for financing high budget deficits an ingredient of stabilization programs was establishment of the mint parity of national currencies, or return to gold standard

return of other countries to the gold standard: which mint parity should be used?

1926 1931: Functioning of the Renewed Gold Standard Period

differences in gold standard in the interwar period and before World War I:
mint parity was established at the wrong level, resulting in continued problems in the balance-of-payments adjustments not a real gold standard, rather, a gold exchange standard: assumption of high confidence into countries with a reserve currency to guarantee unconditional conversion of their currencies into gold

1926 1931: Functioning of the Renewed Gold Standard Period

not following the rules of the game or different priorities of national economic policies :
countries started to systematically give priority to internal economic goals and relatively lower importance to balance-of-payments equilibrium

changed significance of the short-run capital flows:

flows under the strong influence of lowered confidence into mint parities, which was reflected mostly in escape of capital from weak currencies

1926 1931: Functioning of the Renewed Gold Standard Period

End of the gold standard:
convergence of different causes that pressured the already weak international monetary system of renewed gold standard at the end of 1920s deflation and unemployment; New York Stock Exchange crisis (1929) decreased confidence

1931 1944: Period of Economic Nationalism

cannot talk about the existence of an international monetary system economic nationalism:
competitive devaluations protectionism

trade wars, international trade cut almost in half less international provision of credit and investment