c

d

 
 


 

V The market where the commodity traded is

Currency.

V Price of each currency is determined in term of

other currencies.

V Purposeñ to help international trade and

investment

6
 


V 3lobally, operations in the foreign exchange market started

in a major way after the breakdown of the Bretton Woods
system in 1971.

V This also marked the beginning of floating exchange rate

regimes in several countries.

V Over the years, the foreign exchange market has emerged as

the largest market in the world.

V As in the rest of the world, in India too, foreign exchange

constitutes the largest financial market by far. u
 

VIn India the foreign exchange market originated in 1978

VIt was in the 1990¶s that the Indian foreign exchange market
witnessed far reaching changes along with the shifts in the currency
regime.

VFollowing the recommendations of the ³Rangarajan

Committee´ on Balance of Payments, the exchange rate of the
rupee (which was earlier pegged) was floated partially in March
1992 and fully in March 1993.

VThe unification of the exchange rate was instrumental in

developing a market-determined exchange rate of the rupee and
was an effort towards current account convertibility, which was
achieved in August 1994.
Œ
 


V A further impetus to its¶ development was provided

with the setting up of an Expert 3roup on Foreign
Exchange Markets in India (Chairmanñ Mr O.P.
Sodhani), which submitted its report in June 1995.

V The 3roup made several recommendations for

deepening and widening of the Indian foreign
exchange market.

V Consequently, beginning from January 1996, wide-

ranging reforms have been undertaken in the Indian
foreign exchange market. ‰
V In 2005, an Internal Technical 3roup was constituted
to undertake a comprehensive review of the measures
initiated by the RBI and identify areas for further
liberalisation. or relaxation of restrictions

·
    

V Enhanced risk-bearing capacity of banks along with rising

foreign exchange trading volumes and finer margins.

V The foreign exchange market has acquired depth

V The conditions in the foreign exchange market have also

generally remained orderly

V India was able to keep the spillover effect of the Asian crisis to
a minimum throughñ
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^
  
    

V The exchange rate of the rupee was officially determined by

the RBI in terms of a weighted basket of currencies of India¶s
major trading partners

V The foreign exchange market in India till the early 1990s,

remained highly regulated with restrictions on external
transactions, barriers to entry, low liquidity and high
transaction costs

V The strict control on foreign exchange transactions through the

Foreign Exchange Regulations Act (FERA) had resulted in
one of the largest and most efficient parallel markets for
foreign exchange in the world, 
 
 (unofficial)
market £
    

V Fixed ERM, with occasional devaluations.

V Reserve Bank of India (RBI) to fix its buying & selling

rates for Authorized Dealers and their rates for customers.

V Residents not allowed to hold foreign exchange.

V Only ADs (Banks), allowed to deal in Forex.

V Forex available only for current account transactions.

(goods & services) and some other personal transactions
viz. travel, education, medical treatment etc.

G
    

V Reserve Bank of India (RBI) to buy and sell forex

from and to ADs, at its buying and selling rates for
Authorized Dealers.

V Reserve Bank of India (RBI) to provide forward cover

to ADs for importers and exporters as well as foreign
currency loans mobilized by corporates from abroad.

V Exporters of goods and services, were bound to sell

forex to an AD at rates prescribed by Reserve Bank of
India (RBI).

V Elaborate system of reporting by ADs to Reserve Bank

c
of India (RBI).
  
 

V FERA was introduced at a time when Forex reserves

were low

V Was based on the presumption that all foreign

exchange earned by Indians rightfully belonged to the
3overnment, so should be surrendered to the RBI.

V It also regulated all transactions with non-residents

V Primarily prohibited all Forex transactions except

those permitted by the RBI
cc
  
 

Basic purpose of FERA was toñ

V {
   


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Following the recommendations ³î
odhani Expert Committee,´

since 1996, wide-ranging reforms have been undertaken for deepening
and widening of the Indian foreign exchange market.

Recommendations implemented by RBI include:

×or Banks, freedom toñ

V× 

  
  
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×or corporates:-

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×or improvements in internal controlsñ-

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V FEMA was the required since FERA was

incompatible with the pro-liberalization policies of
the 3OI.

V FEMA sought to make foreign exchange offences

 offences, as opposed to 
 offences under
FERA

c‰
     

VDuring 1994-95 there was upward pressure on the rupee because of

foreign portfolio capital inflow that was now allowed to enter India.

VHowever, the rupee was not allowed to appreciate but was kept
constant by the RBI.

VThis was due to the conflict between the objectives of export

promotion and the free movement of the rupee.

VThe market was not freely allowed to determine the exchange rate of
the rupee. If it had, the rupee would have appreciated.

c·
     

VIn 1995 the initial surge was over and buying pressure from
FII¶s reduced.

VAs the rupee continued to be overvalued the current account

deficit started mounting.

VThere was downward pressure on the rupee.

VA depreciation in the rupee was welcome as the appreciation

in the real exchange rate had made exports uncompetitive.

c^
     

VIn the following year, the appreciation of the US dollar against other
major currencies put upward pressure on the rupee.

VIn 1997-88 and 1998-99 the RBI allowed the rupee to be more or less
determined by the market.

V In this period there has been little pressure on the nominal rate to
appreciate and whenever political, economic or other reasons have
introduced volatility in the foreign exchange market the RBI has
intervened.

VThe stated objective of the RBI¶s exchange rate policy is to reduce

volatility and speculation in the foreign exchange market and to keep the
rate in line with economic fundamentals

c£
  

V The Indian foreign exchange market is a decentralised multiple

dealership market comprising two segments ±
± Spot market
± Derivatives market

V In the spot market, currencies are traded at the prevailing rates

and the settlement or value date is two business days ahead.

V The derivatives market encompasses forwards, futures, swaps

and options

cG
  

V The Reserve Bank intervenes in the market essentially to

ensure orderly market conditions

V Foreign Exchange Dealers¶ Association of India (FEDAI)

plays a special role in the foreign exchange market for
ensuring smooth and speedy growth of the foreign exchange
market in all its aspects.

V All ADs are required to become members of the FEDAI

V The FEDAI is also the accrediting authority for the foreign

exchange brokers in the interbank foreign exchange market.

6

 
  
 

 
 

  

 

    

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In the Forex market rates are always quoted µtwo way¶.

Two way quote gives both µBid¶ and µOffer¶.
e.g.
USD/INR= 48.50 / 50
Bid / Offer

6·
  
  
 

The bank quoting the price is µprice maker¶ or

µmarket maker¶.

The bank asking for the price or µquote¶ is the

µprice taker¶ or µuser¶.

6^
  


Foreign exchange transactions are settled through Nostro and

Vostro accounts
accounts..

VNostro ñ our account with banks abroad

abroad.. Reserve Bank of
India (RBI) maintains various Nostro accounts in a number
of countries
countries..

VVostro ñ their account with us.

us. Many multilateral agencies
(e
(e..g. IMF, World Bank) maintain their Nostro accounts at
Reserve Bank of India (RBI).
(RBI).

6£
 !"#$%& '()*&%#$+

Exposure to exchange rate movementñ-

‡ Any sale or purchase of foreign currency entails

foreign exchange risk.

‡ Foreign exchange transaction affects the net asset

or net liability position of the buyer/seller.

‡ Carrying net assets or net liability position in any

currency gives rise to exchange risk.
6G
 J
 J
J
J
J J

‡ NOP is the Net Asset/Net Liability position in all FCs

together

‡ Net Asset Position is also called è
 or ³Overbought

³ position.

‡ Net liability Position is also called è
 or ³Oversold

³ position.

‡ NOP is a single statistic that provides a fairly good idea

about exchange risk assumed by the bank.

‡ Its major flaw is that FX exposures in third currencies

u
remain hidden.

P 
P)  inill)

peningPosition à 0.00

Ready Purchases from Exporter à 1.00

Fwd Purchases from Corporate (1.00 Euro) Ã 0.90

Ready Sell to importer ( 60 Mill Yen) - Ã 0.50

Fwd Sell to Corporate - Ã 0.40


PP



 
 
 
 



 
 


×oreign change posure

FX Exposure is the higher of the long and short positions in FCs.


P 

Currency-wise NOP in equivalent INR


 


ollar -10
en 10
uro -10
Pound 10
otal -2 2

Net Open Position is 0 while exposure is 2. u6

 


 

‡ In pursuance of the recommendations of the Sodhani

Committee, the RBI had set up the Clearing Corporation of
India Ltd. (CCIL) in 2001 to mitigate risks in the Indian
financial markets.

‡ The CCIL commenced settlement of foreign exchange

operations for inter-bank USD-INR spot and forward trades
from November 8, 2002 and for inter-bank USD-INR cash
trades from February 5, 2004.

‡ The CCIL undertakes settlement of foreign exchange trades

and all spot and cash transactions are guaranteed for settlement
from the trade date.
uu

  

‡ Continuous improvement in market infrastructure has had its

impact in terms of enhanced depth, liquidity and efficiency of
the foreign exchange market.

‡ The turnover in the Indian foreign exchange market has

grown significantly in both the spot and derivatives segments
in the recent past.

‡ Along with the increase in onshore turnover, activity in the

offshore market has also assumed importance.

‡ With the gradual opening up of the capital account, the process

of price discovery in the Indian foreign exchange market has
improved, thereby increasing market efficiency. uŒ

  

‡ The efficiency/liquidity of the foreign exchange market is

often gauged in terms of bid-ask spread.
‡ The low and stable bid-ask spread in the foreign exchange
market indicates that market is efficient with underlying low
volatility, high liquidity and less of information asymmetry.

u‰

  

‡ Turnover in the foreign exchange market was 6.6 times of the

size of India¶s balance of payments during 2005-06 as
compared with 5.4 times in 2000-01.

‡ With the deepening of the foreign exchange market and

increased turnover, income of commercial banks through
treasury operations has increased considerably.
u·
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·

‰
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 (0
‡ ×rom -2 to  :
± Rupee corrected as it was highly overvalued vis-à-vis other currencies.
± From Rs. 18/Ã (1991-92) to Rs. 35/Ã (1995).
‡ ×rom  to 2:
± The partially convertible rupee has depreciated from 30 in 1995 to 49.90 in 2001 against
the US dollar on greenback¶s strength globally.
± The US dollar index posted a high of 121 during 2001 from low of 80.00 posted during
1995.
‡ ×rom 22 to 2:
± the rupee has been appreciating or the USD has been falling to post a low of 39.00, as the
US dollar slid against the major currencies.
‡ ×rom 2 onwards:
± The Indian rupee started losing against the US dollar from 2008 onwards on global
economic recession and as US Dollar attracted some buying interest as a safe heaven
investment
± The USDINR rose to a high of 52.13 following short supply in the market. Among all
asset classes, the US dollar performed during the period as safe heaven instrument
despite its own structural problems.
± The period marked with massive FII outflow from India following redemption pressure
of funds in their home countries.
 (9!2
,
·

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cGG6 cGGŒ cGG· cGG£ 6 6 6 6 Œ 6 · 6 £ 6 c 6 c6

 (9!2
‡  P appreciation:
± From 1991-92 to 1995 Rupee corrected as it was highly overvalued vis-à-vis other
currencies.
± From Rs. 18/Ã (1991-92) to Rs. 35/Ã (1995).
This is reflected v/s JPY.
‡  P depreciation:
± Asian crisis of 1997 hit Japan harder than India. Hence, depreciation.
‡ 2 P depreciation:
± This transition is due to dot com bubble burst
‡ 2 P depreciation:
± Financial crisis, recession. JPY suffered.
± Rupee relatively insulated. Hence fall for JPY.
‡ 2 P appreciation:
± Capital and current a/c surplus ± Japan
± Heavy investments by China into JPY bonds.
 (
(2
 
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(#
(2
 (
(2
‡ teepdeclinein:
- 1990-2006ñ Waves of public protests, particularly in rural areas against Chinese
3overnment
‡ lowdownin:
- 1995ñ Overheating of the economyñ 17% Inflation rate,
- 1995, Oct.ñ Earthquake in Yunnan (6.5 at Richter scale). 50 people die and 6,000 are
injured. 170,000 people homeless.
‡ lowdownPost:
- 1998-1999ñ Slow-down of the Chinese economy - partly due to Asian Financial Crisis
- 1998ñ Worst flooding in years - 230 million people affected and 3,656 dead
- 1998, Aprilñ One of the most devastating sandstorm in decades is raging in Beijing for
two days, blocking sunlight
‡ Peakat22:
- 2001, Nov.ñ China becomes a member of the World Trade Organization
- 2002 Febñ A series of riots in India
 (
(2
‡ ecline post 22:
- 2001, Juneñ 3rowing tension across the Taiwan Strait
‡
ppreciationfrom2-:
- Rapid Economic growth in China ( 3DP in 2007 ± 10.6%)
- International Balance of Payment surplus and large Forex Reserves
- Rising Interest Rates
‡ ecline in 2:
- Earthquake of magnitude 7.1 on Richter scale hit southern Qinghai province in China
- The European debt crisis
- Major Oil Spill in China
     

‡ The Indian Foreign Exchange Market and the Equilibrium Real

Exchange Rate of the Rupee - Ila Patnaik and Peter Pauly

‡ www. rbi.com

‡ www.tradingeconomics.com

‡ www.economictimes.com

ŒŒ
Œ‰