Vous êtes sur la page 1sur 62


SESSION (2011-2012)




ROLL NO.1100122037



Table of Contents
Certificate Acknowledgement Declaration Preface Conceptual Framework of Foreign Exchange Market 1.1 What is Foreign Exchange
1.2 History 1.3 FOREX Market 1.4 Indian Foreign Exchange Market 1.5 FERA EX control manual and turnover

Research Methodology
2.1 Objectives of The Study 2.2 Tools for Data Collection or selection of forex 2.3 Limitation of The Study

Organization and Regulation of FOREX Market

3.1 Organization of FOREX Market 3.2 Exchange Regulation in India 3.3 Exchange Rate Mechanism in India 3.4 Comparative analysis 3.5 Market size & liquidity 3.6 financial institutions

Analysis of FOREX Market in India

4. 1 Short Term Factors a) Commercial Factors b) Financial Factors 4.2 Long Term Factors a) Currency and Credit Conditions b) Political and Economic Conditions

Risk aversion Conclusion, Recommendations and Future

Prospects of FOREX Market Bibliography


Hereby declare that the project report entitled

FOREX and its

Comparative analysis submitted for the degree of Master of Business Administration , is my original work and the project report has not formed the basis for the award of any diploma, degree, associate ship, fellowship or similar other titles. It has not been submitted to any other university or institution for the award of any degree or diploma.


MBA-1st year (II SEM)

It is an honor to receive guidance from towering personalities and I suppose myself more blessed for having received this distinction from the galaxy of stars who have not only enlightened my knowledge in this field and made this work possible but have also, through their pearls of experience, enriched the treasure of my mind., the indebtedness of which, guidance that I most humbly received with Zeal` and Zest. I know not in what terms to acknowledge, yet, I most humbly take this opportunity to pay due reverences to few of them. Though at the onset of ambitious project one always encounters certain difficulties in the beginning, however, overcoming these difficulties of the project as well as making it a success, greatly depends on the encouragement, inspiration, and help given by my Dean PROF. DR ZEESHAN AMIR and my HOD MS ASMA FAROOQUE through her invaluable guidance and help. I would also like to thank my guide MR. AMIT KUMAR GOEL for his unconditional support and guidance. I would also like to thank all faculty members for their continuous support. . No words would be adequate to convey thank to my parents, and other family members who have always been a source of inspiration and encouragement to me. I must also express my sincere gratitude and indebtedness to all my friends for their support and patience.

Hasan faraz siddiqui


This is to certify that Mr. Hasan faraz siddiqui roll no. 1100122037 Enrolment No.1100101467 has completed her dissertation on FOREX AND ITS COMPARATIVE ANALYSIS under my supervision in partial fulfillment of the requirements for the award of MANAGEMENT OF BUSINESS ADMINISTRATION FINANCE (MBAF). The present work, in my opinion, is suitable for submission for the said purpose.

AMIT KUMAR GOEL Assistant professor

Faculty of management and research Integral university

The foreign exchange market is the market where one currency is traded for another. This market is somewhat similar to the over the counter market in securities. The trading in currencies is usually accomplished over the telephone or through the telex. With direct dialing telephone service anywhere in the word, foreign exchange markets have become truly global in the sense that currency transactions now require only a single telephone call and take place twenty four hours per day. The different monetary centers are connected by a telephone network and video screens and are in constant contact with one another, thus forming a single international foreign exchange market. However, the currencies and the extent of the participation of each currency in this market depend on local regulations, which vary form country to country. 1. Deals with the introduction and conceptual framework of foreign exchange market in India. It also deals with the structure of Indian Forex Market. 2. Deals with the methodology adopted in the research process outlining the objectives of the study, research methodology and limitations faced while conducting the study. 3. Deals with organization and regulation of forex market as well as management of exchange risk, exchange rate mechanism. 4. Deals with the analysis of the foreign exchange market in India. It covers the long term and short term factors which account to the problems. 5.Deals with the conclusion, recommendations and future prospects of forex market in India.


The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.[1] The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the European Union member states especially Eurozone members and pay Euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation on the change in interest rates in two currencies.[2] In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system. The foreign exchange market is unique because of

its huge trading volume representing the largest asset class in the world leading to high liquidity; its geographical dispersion;

its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday; the variety of factors that affect exchange rates; the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, not with standing currency intervention by central banks. According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion. The $3.98 trillion break-down is as follows:

$1.490 trillion in spot transactions $475 billion in outright forwards $1.765 trillion in foreign exchange swaps $43 billion currency swaps $207 billion in options and other products

The determinants of forward premia in Indian forex market

Indian forex market, in the recent times, experienced considerable volatility specifically in respect of USD - INR market segment. INR was traded at Rs. 48.92 per USD during April 2002; gradually, INR appreciated to Rs. 38.50 per USD by April 2008; from the highs of Rs. 38.50 per Dollar, the Rupee plummeted and touched a low of 42.67 per USD last week and is slowly moving towards the 43.00 mark. The partially convertible Rupee fell by more than 7% to a 13 month low this year reversing a 12% gain in 2007. The South-ward journey of Rupee is attributed to spiraling crude prices ($ 122 per barrel), inflation driven by high commodity prices and moderated inflows from FIIs due to slow down in international capital markets creating a demand supply mismatch.

RBI, as a financial regulator, intervenes in the forex market to prevent excess volatility. Further, RBI does a balancing act by liberalizing limits on foreign exchange inflows and outflows from the point of convertibility angle. In a phased manner, RBI liberalized limits on the overseas investment by Indian Companies. Now Indian companies can invest overseas upto 400% of their net worth and they are also allowed to invest in overseas energy and natural resources sector like oil, gas, coal and mineral ores in excess of the current limits with prior approval. Recently, RBI raised the limit on the overseas investment by Mutual Funds from USD 5 bn to USD 7 bn. RBI raised the limit on individual remittances upto USD 2,00,000 p.a. In its recently announced monetary policy, RBI allowed Indian exporters to realize and repatriate the full value of export proceeds with in a period of 12 months (earlier 6 months) from the date of export. Refining Companies are allowed to hedge upto 50% of the volume of imports during the previous year or 50% of the average volume of imports during the 3 previous financial years, whichever is higher. According to BIS triennial Central Bank Survey 2007, the share of India's daily average forex turnover was at USD 34 billion (increased from 0.3% in 2004 to 0.9% in 2007). India's share in world's exports was at 0.52% in 1990 and increased to 1% in 2007. Thus the Indian Forex market has widened and deepened with the transition to a market determined exchange rate system and liberalization of restrictions on external transactions leading to full current account convertibility and partial capital account convertibility. As all the above mentioned situations do have an impact on exchange rate of Rupee as well as forward premia in respect of USD vis--vis INR, it is interesting to notice the forex developments and their implications especially on exporters / importers and other active forex market players including Banks. As the Banks are the most active forex market players with their presence in Foreign Currency deposits as well as loans, they can transmit their influence on interest rates and on forward premia. While arriving at the forward premia, banks / forex market players try to forecast the future price of the commodity (foreign currency) keeping in view the opportunity cost / carrying cost etc. Forward rate is an outcome of future expected exchange rate, which is a function of price level, interest rates and Balance of Payments

History of foreign exchange in india

Currency trading can draw its history back to the middle ages when global merchant banker devised the system of using bills of exchange. It is however changes which have occurred throughout the twentieth century which have actually shaped trading in the global currency market we see today. In the 1930s the British pound was measured to be the world's principle trading currency and was the currency detained by many countries as their main reserve currency. In spite of its size India plays a comparatively small role in the world financial system. Until the 1980s the government did not make exports a priority. In the 1950s and 1960s Indian officials thought that trade was biased against developing countries and that forecast for exports were severely limited. So, the governments meant at self-sufficiency in most products during import replacement with exports cover the cost of residual import necessities. Foreign trade was subjected to strict government controls which consisted of an all-inclusive system of foreign exchange and direct controls over imports and exports. As a result India's share of world trade shrank from 2.4 percent in FY 1951 to 0.4 percent in FY 1980. Mainly because of oil price increases in the 1970s which contributed to balance of payments difficulties governments in the 1970s and 1980s located more emphasis on the promotion of exports. They hoped exports would provide foreign exchange needed for the introduce of oil and high-technology capital goods. However, in the early 1990s India's share of world trade stood at only 0.5 percent. In FY 1992, imports accounted for 9.3 percent of GDP and exports for 7.7 percent of GDP. No one product dominates India's exports. In FY 1993 handicrafts, gems, and jewelry formed the most main sector and accounted for an estimated US$4.9 billion (22.2 percent) of exports. Since the early 1990s India has become the world's largest processor of diamonds (imported in the rough from South Africa and then fabricatedinto jewelry for export). Along with other semiprecious commodities, such as gold, India's gems and jewelry accounted for 11 percent of its foreignexchange receipts in early 1993. Textiles and ready-made garments combined were also a significant category accounting for an predictable US$4.1 billion (18.5 percent) of exports. Other significant exports include industrial machinery, leather products, chemicals and related products. The main imports are petroleum products valued in FY 1993 at nearly US$5.8 billion or 24.7 percent of principal imports and capital goods amounting to US$4.2 billion or 21.8 percent of

principal imports. Other important import categories are chemicals, dyes, plastics, pharmaceuticals, uncut precious stones, iron and steel, fertilizers, nonferrous metals, and pulp paper and paper products India's most significant trading partners are the United States, Japan, the European Union, and nations belonging to the Organization of the Petroleum Exporting Countries (OPEC). From the 1950s until 1991, India also had close trade links with the Soviet Union but the breakup of that nation into fifteen independent states led to a refuse of trade with the region. In FY 1993 some 30 percent of all imports came from the European Union, 22.4 percent from OPEC nations, 11.7 percent from the United States, and 6.6 percent from Japan. In that same year, 26 percent of all exports were to the European Union, 18 percent to the United States, 7.8 percent to Japan, and 10.7 to the OPEC nations. Trade and investment with the United States seemed likely to knowledge an upswing following a January 1995 trade mission from the United States led by Secretary of Commerce Ronald H. Brown and including top executives from twenty-six United States companies. During the weeklong visit some US$7 billion in business deals were agreed on frequently in the areas of infrastructure development, transportation, power and communication systems, food processing, health care services, insurance and financing projects, and automotive catalytic converters. In turn greater access for Indian goods in United States markets was sought by Indian officials. In February 1995 in a bid to improve commercial prospects in Southeast Asia, India signed a fourpart agreement with the Association of Southeast Asian Nations (ASEAN). The deal covers trade, investment, science and technology, and tourism, and there are prospects for further agreements on joint ventures, banks and civil aviation. India's balance of payments position is closely connected to the balance of trade. Foreign aid and remittances from Indians employed overseas, however, make the balance of payments more favorable than the balance of trade.Foreign exchange system in India - The central government in India
has wide powers to control transactions in foreign exchange. Until 1992 all foreign investments in India and the repatriation of foreign capital required prior approval of the government. The Foreign-Exchange Regulation Act, which governs foreign investment, rarely allowed foreign majority holdings. However, a new foreign investment policy announced in July 1991 prescribed automatic approval for foreign

investments in thirty-four industries designated high priority, up to an equity limit of 51 percent. Initially the government required that a company's automatic approval must rely on matching exports and dividend repatriation, but in May 1992 this requirement was lifted, except for low-priority sectors. In 1994 foreign and nonresident Indian investors were allowed to repatriate not only their profits but also their capital. Indian exporters are also free to use their export earnings as they see fit. However, transfer of capital abroad by Indian nationals is only permitted in special circumstances, such as emigration. Foreign exchange in India is automatically made available for imports for which import licenses are issued.

Because foreign-exchange transactions in India are so tightly controlled, Indian authorities are able to manage the exchange rate, and from 1975 to 1992 the rupee was tied to a trade-weighted basket of currencies. In February 1992, the government began moves to make the rupee convertible, and in March 1993 a single floating exchange rate was implemented. In July 1995, Rs31.81 were worth US$1, compared with Rs7.86 in 1980, Rs12.37 in 1985, and Rs17.50 in 1990.

Introduction to Indian Foreign Exchange Market Highlights & Motivation:

Happenings in the foreign exchange market (henceforth forex market) form the essence of the international finance. The foreign exchange market is not limited by any geographical boundaries. It does not have any regular market timings, operates 24 hours 7 days week 365 days a year, characterized by ever-growing trading volume, exhibits great heterogeneity among market participants with big institutional investor buying and selling million of dollars at one go to individuals buying or selling less than 100 dollar. In this module, a brief introduction to forex market, details about trading volume, market participants, different types of forex products are discussed. In addition, brief history and evolution for exchange market would also be discussed. Learning Objectives: Forex market in India Forex Market in India: A historical perspective FERA Vs. FEMA Pre-liberalization exchange rate regime in India and Hawala market Brief introduction to currency convertibility in current & capital account.

Forex Market in India: Traditionally Indian forex market has been a highly regulated one. Till about 1992-93, government exercised absolute control on the exchange rate, export-import policy, FDI ( Foreign Direct Investment) policy. The Foreign Exchange Regulation Act(FERA) enacted in 1973, strictly controlled any activities in any remote way related to foreign exchange. FERA was introduced during 1973, when foreign exchange was a scarce commodity. Post independence, union governments socialistic way of managing business and the license raj made the Indian companies noncompetitive in the international market, leading to decline in export. Simultaneously India import bill because of capital goods, crude oil & petrol products increased the forex outgo leading to sever scarcity of foreign exchange. FERA was enacted so that all forex earnings by companies and residents have to reported and surrendered (immediately after receiving) to RBI (Reserve Bank of India) at a rate which was mandated by RBI. FERA was given the real power by making any violation of FERA was a criminal offense liable to imprisonment. It a professed a policy of a person is guilty of forex violations unless he proves that he has not violated any norms of FERA. To sum up, FERA prescribed a policy nothing (forex transactions) is permitted unless specifically mentioned in the act. Post liberalization, the Government of India, felt the necessity to liberalize the foreign exchange policy. Hence, Foreign Exchange Management Act (FEMA) 2000 was introduced. FEMA expanded the list of activities in which a person/company can undertake forex transactions. Through FEMA, government liberalized the export-import policy, limits of FDI (Foreign Direct Investment) & FII (Foreign Institutional Investors) investments and repatriations, cross-border M&A and fund raising activities. Prior to 1992, Government of India strictly controlled the exchange rate. After 1992, Government of India slowly started relaxing the control and exchange rate became more and more market determined. Foreign Exchange Dealers association of India (FEDAI), set up in 1958, helped the government of India in framing rules and regulation to conduct forex exchange trading and developing forex market In India. A major step in development of Indian forex market happened in 2008, when currency futures (Indian Rupee and US Dollar) started trading at National Stock Exchange (NSE).

Since the introduction, the turnover in futures has increased leaps and bound. Though banks and authorized dealers were undertaking forex derivatives contracts, but the introduction of exchange traded currency futures marked a new beginning as the retail investors were able to participate in forex derivatives trading.


There is an elaborate machinery to enforce Exchange Control Regulations in our country. The machinery comprises of the controller of the Exchange Control department of the Reserve Bank of India at the helm of affairs, which in turn has empowered the Banks dealing in foreign exchange to deal with general public for their foreign exchange requirements. This authority enforces the provisions of the Foreign Exchange Regulations Act and has the powers to deal with any infringement or violation of the provisions of the Act.


All the provisions of the FERA have been transcribed in the banking terminology by the Reserve Bank of India to facilitate the day to day transactions between Reserve Bank, between the various dealers and the general public. Exchange control in India is administered by the Reserve Bank of India in accordance with the general policy laid down by the Union Government in consultation with the Reserve Bank. The Bank has an Exchange Control Department which is entrusted with this functions. Under the system, the Reserve Bank is authorized to license export of gold, silver, currency notes, securities, and a variety of other transactions involving the sue of foreign exchange. For foreign exchange transactions, which the general public conducts with the authorized dealers in foreign exchange, the Reserve Bank of India has laid down general instructions for the guidance of the latter. The directions cover all transactions relating to imports and exports, foreign travel payments, family maintenance

remittances by foreign nationals, transfers of investment income, capital transfers by foreign and Indian Nationals and other invisible items. Some of these transactions particularly those pertaining to capital transfers, have to be referred by the authorized dealers to the Reserve Bank for its prior approval. Some remittances may, however, be made by the authorized dealers without prior approval of the Reserve Bank, such as those for foreign Nationals seeking to remit a part of their, earnings for the maintenance of their families abroad, provided the amounts are within limits specified by the Reserve Bank. The institutional framework of the exchange control system also compromised of a special machinery for enforcement and for dealing with any infringements of the provisions of the Act. The function is entrusted to the Directorate of Enforcement attached to the Union Ministry of Finance. The directorate deals with offenders who violate the control provisions and is authorized to take punitive action. It is also empowered to adjudicate in certain cases of infringement.

Purchases and Sales by Authorized Dealers

Authorized dealers purchase and sell foreign currencies in accordance with the Regulations . Purchase: They purchase T.Ts., M.Ts., drafts, bill etc., freely from banks and the general public. The receipt of remittances from any country is free and banks are, therefore allowed to purchase freely. Purchase of foreign currencies is also done from their overseas branches and correspondents for the purpose of making rupee payments into non-resident accounts in India and also for making payments to residents. The authorized dealers and authorized money changers purchase foreign currency notes, coins, and travelers, cheques from travelers coming from abroad. The amounts purchased are endorsed on the reverse of the customs stamped currency declaration forms of the travelers. Foreign currency notes and coins are also purchased from other authorized dealers and money changers.

Sales: Sales of foreign currency are made by authorized dealers subject to control regulations. No remittances may be made to countries advised from time to time and no transactions may be carried out with persons, firms or banks residents in those countries. For the purpose of sales persons, firms, and banks residents in Nepal are treated as non- residents.

Foreign Exchange Market in India: Historical Perspective:

Indian forex market since independence can be grouped in three distinct phases. 1947 to1977: During 1947 to 1971, India exchange rate system followed the par value system. RBI fixed rupees external par value at 4.15 grains of fine gold. 15.432grains of gold is equivalent to 1 gram of gold. RBI allowed the par value to fluctuate within the permitted margin of 1 percent. With the breakdown of the Bretton Woods System in 1971 and the floatation of major currencies, the rupee was linked with Pound-Sterling. Since Pound-Sterling was fixed in terms of US dollar under the Smithsonian Agreement of 1971, the rupee also remained stable against dollar. 1978-1992: During this period, exchange rate of the rupee was officially determined in terms of a weighted basket of currencies of Indias major trading partners. During this period, RBI set the rate by daily announcing the buying and selling rates to authorized dealers. In other words, RBI instructed authorized dealers to buy and sell foreign currency at the rate given by the RBI on daily basis. Hence exchange rate fluctuated but within a certain range. RBI managed the exchange rate in such a manner so that it primarily facilitates imports to India. the FERA Act was part of the exchange rate regulation practices followed by RBI. Indias perennial trade deficit widened during this period. By the beginning of 1991, Indian foreign exchange reserve had dwindled down to such a level that it could barely be sufficient for three-weeks worth of imports. During June 1991, India airlifted 67 tonnes of gold, pledged these with Union Bank of Switzerland and Bank of England, and raised US$ 605 millions to shore up its precarious forex reserve. At the height of the crisis,

June 1991, rupee was officially devalued by 19.5% from 20.5 to 24.5 to 1 US$. This crisis paved the path to the famed liberalization program of government of India to make rules and regulations pertaining to foreign trade, investment, public finance and exchange rate encompassing a broad gamut of economic activities more market oriented. 1992 onwards: 1992 marked a watershed in Indias economic condition. During this period, it was felt that India needs to have an integrated policy combining various aspects of trade, industry, foreign investment, exchange rate, public finance and the financial sector to create a market-oriented environment. Many policy changes were brought in covering different aspects of import-export, FDI, Foreign Portfolio Investment etc. One important policy changes pertinent to Indias forex exchange system was brought in -- rupees was made convertible in current account. This paved to the path of foreign exchange payments/receipts to be converted at market-determined exchange rate. However, it is worthwhile to mention here that changes brought in by government of India to make the exchange rate market oriented have not happened in one big bang. This process has been gradual. Convertibility in current account means that individuals and companies have the freedom to buy or sell foreign currency on specific activities like foreign travel, medical expenses, college fees, as well as for payment/receipt related to export-import, interest payment/receipt, investment in foreign securities, business expenses etc. An related concept to this is the convertibility in capital account. Convertibility in capital account indicates that Indian people and business houses can freely convert rupee to any other currency to any extent and can invest in foreign assets like shares, real estate in foreign countries. Most importantly Indian banks can accept deposit in any currency. Even though the exchange rate has been market determined, from time to time RBI intervenes in spot and forward market, if it feels exchange rate has deviated too much.

Forex Exchange Turnover

According to the RBI report (September 2009) by Goyal, Nair & Samataray titled Monetary Policy, Forex Markets, and Feedback under Uncertainty in an Opening Economy, The extract from the report highlights the foreign exchange turnover in India

Indian FX market has grown many times over the last several years. The average daily turnover, which was in the vicinity of US $ 3.0 billion in 1998-99 grew to US $ 18 billion during 2005-06. The turnover rose considerably to US $ 48 billion during 2007-08 with the monthly turnover crossing US $ 65 billion in February 2007. The inter-bank to merchant turnover ratio halved from 5.2 during 1997-98 to 2.3 during 2007-08 reflecting the growing participation in the merchant segment of the foreign exchange market. The spot market remains the most important FX market segment accounting for 51 per cent of the total turnover. Its share has declined marginally in recent years due to a pick up in the turnover in derivative segment. Even so, Indian derivative trading remains a small fraction of that in other developing countries such as Mexico or South Korea. Short-term instruments with maturities of less than one year dominate, and activity is concentrated among a few banks (IMF 2008). trading remains a small fraction of that in other developing countries such as Mexico or South Korea. Short-term instruments with maturities of less than one year dominate, and activity is concentrated among a few banks (IMF 2008). India has been one of the earliest issuers of coins in the world (6th Century BC). The origin of the word "rupee" is found in the word rup or rupa, which means "silver" in many IndoAryan languages such as Hindi. The Sanskrit word rupyakam means coin of silver. The derivative word Rupaya was used to denote the coin introduced by Sher Shah Suri during his reign from 1540 to 1545 CE. The original Rupaya was a silver coin weighing 175 grains troy (about 11.34 grams) . The coin has been used since then, even during the times of British India. Formerly the rupee was divided into 16 annas, 64 paise, or 192 pies. In India decimalization occurred India in 1957.

Pre-Liberalization exchange rate regime in India and Hawala Market:

At this juncture, it is pertinent to discuss Hawala market operating in India before liberalization. Before 1992, RBI was strictly controlling the exchange rate. This created a parallel foreign exchange market a black market in foreign exchange popularly known as Hawala Market. At this juncture, it is pertinent to discuss Hawala market operating in India before liberalization. Before 1992, RBI was strictly controlling the exchange rate. This created a parallel foreign exchange market a black market in foreign exchange popularly known as Hawala Market. Hawala market is nothing but illegal foreign exchange market where forex trading happen at rates different than the rate mandated by the RBI. When the official rate overvalues the home currency, Hawala market starts operating. Example of a Hawala Transaction: a NRI working in USA wants to send 20,000 US$ to his family member. If he send this money through bank, he receives rupees at prevailing exchange rate of INR 35/US$. But in the black market, the exchange rate is INR 40/US$. Example of a Hawala Transaction: a NRI working in USA wants to send 20,000 US$ to his family member. If he send this money through bank, he receives rupees at prevailing exchange rate of INR 35/US$. But in the black market, the exchange rate is INR 40/US$. In other words, RBI puts a value of INR.35 per US$ , when it should have been Rs.40/US$. Hence INR is overvalued at the official rate. The NRI contacts a hawala operator in USA and gives $20,000 to him. The USA hawala operators counterparty in India, pays Rs. 40/US$ to the family members of NRI here in India. The transaction between hawala dealer in USA and his counterparty India are done through smugglers. During the heyday of hawala transactions in 1990s, it was a common knowledge that exporters under invoice their export earnings and importers over invoice their imports goods ( so as to increase the cost of import denominated in foreign currency) and the

differences are kept abroad and later repatriated back through Hawala route. Even after 17 years of liberalization and even though exchange rate is market determined by supply & demand forces, Hawala market still operates, though at a smaller scale. According to a news report in Hindu ( March 2005), many people working in the Gulf countries opt for the `pipe' or Hawala transactions for obvious reasons of convenience and speedy transactions. No bank can beat these operators in delivering the money so fast, and that too at the receiver's doorstep! The ramifications of Hawala market operations are manifold. In fact, through Hawala market, the money laundering is undertaken. A very informative article on Hawala Transactions are available at Interpol website It is probably one of the most comprehensive pieces of document on Hawala market

A Brief Look at Foreign Exchange History

1973 was the year where the foreign exchange market (AKA Forex or FX) originated. But as we all know everybody is familiar with money since before even the Pharaoh's time. The first paper money was used by the Babylonians as well as the use of receipts. However, the first and true traders of money came from the Middle East; they were the first to exchange one currency to another, usually they exchanged coins from one currency to another. When the time of the Middle Ages came about the need for exchanging currency became neccessary. Aside from exchanging coins they began exchanging paper bills. The exchange of paper bills made the trades for merchants more easy and with the help of these new development with money, economies from different regions began to flourish. During World War I the foreign exchange markets were said to be pretty stable. However, after World War I foreign exchange markets became unstable and the risk activity of the market was increased. Then during the Great Depression in 1931 the Foreign Exchange market's activity became quiet.

The transition period for the Foreign Exchange market occurred from 1931 to 1973. The changes had a wide effect on the economy of different countries. It was after World War II that the great major transformation occurred in the Foreign Exchange Market. France, Great Britain and the United States all met up together at the Financial Conference in Bretton Woods to talk about the new economic order that would be set globally. It was the Great Britain's currency, which is the British Pound, that the major currencies were compared to. In the hope of stabilizing the economy, the Bretton Woods Accord was founded. This gave the global economy a chance to restore their environment and make it stable. The Bretton Woods Accord was active until the year 1971. After long years of battle it finally failed. However, Bretton Woods accomplished what it set out to do and that was making Europe and Japan's economics stable. After the fall of Bretton Woods Accord, the Smithsonian Agreement came to existence; this was in December of 1971. The Smithsonian Agreement had similarities with the Bretton Woods but this time it allowed currencies to fluctuate. Nevertheless, the Smithsonian Agreement collapsed in the year 1973. Today, major currencies can now move from one currency to another freely and without restrictions. Anyone can trade with anyone they wish to trade with. Huge banking firms and individual brokers came into existence. Occasionally Central Banks intervene to move the supply and the demand of price rates. This new Foreign Exchange is what they call a free-float system.

Every research work in supported by number of information and relevant data for analyzing the work done. The information has taken from secondary sources. To complete this research, I have heavily relied on the secondary data as the topic needs a number of published information regarding forex market, recent

developments in it etc. So keeping in view the requirement of the information for this topic, I have relied on a number of magazines, journals, newspapers, books etc. A part from secondary data, I have also collected a number of relevant information from different persons who are associated with the derivative segments of Indian forex market.


1. To assess the evolution of FOREX in India. 2. To identify the growth and development of FOREX in India. 3. To evaluate the contribution of FOREX in economic development of India.
4. FOREX Market in India: A historical perspective



6. Pre-liberalization exchange rate regime in India and Hawala market. 7. Brief introduction to currency convertibility in current & capital account.

8. To study the evolution and growth of Forex market in India. 9. To study the problems faced by the Foreign Exchange market in India. 10. To evaluate the future trends and prospects of Foreign Exchange market in India.

Data required has been collected from secondary sources. For more proper analysis more case studies should be conducted but due to shortage of

time it is not practically possible.

Organization And Regulation of Forex Market

The Foreign Exchange department, which is also being called as the International Banking Division, is one of the important departments of the banks operating in international market. In India also all scheduled commercial banks, both

in the nationalized or non-nationalized sectors, do have Foreign Exchange departments, both at their principal offices as well as offices, in metropolitan centers. This department functions independently under the overall change of some senior executive or a senior officer well-versed in foreign exchange operations as well as in the rules and regulations in force from time to time pertaining to foreign exchange transactions advised by various government agencies. The principal function of a Foreign exchange department is to handle foreign inward remittances as well as outward remittances; buying and selling of foreign currencies, handling and forwarding of import and export documents and giving the consultancy services to the exporters and importers. Besides this, the department also gives the financial assistance in relation to the foreign trade, i.e., it gives assistance to the exporters by way of financing the exports and imports by giving them the financial assistance to clear the consignments or open a letter of credit. The department issues letters of credit for their importer clients and handles letters of credit received from overseas correspondents in favor of exporters from India. Issuance of Performance and the Bid Bond guarantees and tender document is also one of the important functions of the banks that are dealing I foreign exchange. In India, the banks doing foreign exchange business are issued a license to this effect by the Reserve Bank of India under Foreign Exchange Regulation Act, 1973. No bank, not having such license to deal in foreign exchange, can handle foreign exchange operations. Besides Authorized Dealers, licenses are also issued to the Dealers with limited powers to change foreign currency notes, coins and travelers cheques. Such licensees are known as Authorized Money Changers. (i) Transactions between banks and their customers. (ii) Transactions between different banks in the same center. (iii) Dealings between banks in a country and their correspondents, and overseas branches. (iv) The purchase and sale of currencies between the central bank of a country and the commercial banks. (v) The transactions of the central banks of one country, with central banks of

other countries.

Organization of a Foreign Exchange Department

The foreign exchange department of a medium or large sized-bank can be divided into various department and sections such department are locked after by a senior person not lower than the category of a branch manager having both administrative and operational know-how as well as discretionary powers for advances required from time to time by the clients. The in charge of the department functions independently within the overall framework laid down by the Management of the bank. The in charge is assisted in hid day-to-day work by a team of officers, and workmen. One of the important functions of the Foreign exchange department, beside banking operations, is to maintain liaison and correspondence relations with overseas banks who may be their correspondents.


The Foreign exchange department is divided into number of sections, each one equally important and looked after by one officer or a department head. A particular section can be sub-divided into sub-section with specific duties allotted. The sections in Foreign exchange department can be broadly stated as under: 1. Dealers Section This section is the nerve of the foreign exchange department as the exchange rates are computed and advised by this section. The exchange rates are the on a foreign exchange and so any incorrect fixation of rates (price) will turn the profits of the bank into losses and instead of earning from the foreign exchange transactions, the bank may keep on losing. This section is headed by an officer who is called a Dealer. In the morning, before the banking hours begin, the exchange rates of various currencies are computed. The rates are computed on the basis of certain fixed principles which may by either market quotations or any such approved channel. In

India, the Dealer works out the exchange rates on cross rate method based on the sterling rate schedule fixed and advised by FEDAI vis--vis the previous days closing rates in London market. This department calculates and advised both the ready rates as well as forward rates as and when requested. Besides rate computation, it also looks after the foreign currency accounts of the bank and supervises the balancing position in foreign currency accounts maintained abroad. It also controls the exchange position of the department and reconciles the various entries put forth by other sections both for buying as well as selling of foreign exchange. In addition, the section also calculates and tabulates the statistical data required by the principal office of the bank concerned, as well as the Exchange Control Department of the Reserve Bank of India. Such statistics prepared by the bank are to be reported to the authorities on the prescribed forms at the prescribed intervals. This data is very essential and of prime important as the Balance of Trade and Balance of Payments position is arrived at only from the statistics provided by the banks. From the data available from the banks even the import policy is formed and other fiscal fiscal measure adopted by the monetary authorities from time to time depend. This section can be further sub-divided into following subsections: (i) Rate calculation and advising (ii) Forward Exchange contracts (iii) Foreign currency Accounts (iv) Exchange position and control, and (v) Reconciliation of Foreign Currency Accounts.

2. Foreign Remittances Section This section deals with the inward and outward remittances received in the country and sent outside, both on behalf of the transactions taken up by residents and non-residents. Foreign remittances are carried out in the form of cable transfers, mail transfers, demand drafts, travelers cheques and payment instructions by letters. All these forms are widely used both for inward remittances as well as outward

remittances. The officer of this particular department has to be quite well-versed with various regulations in force from time to time and the amendments thereto as strict exchange control regulations are prevailing specially in case of outward remittances in developing and underdeveloped countries, due to the adverse balance of payments position, depleting foreign exchange reserves, and available resources required to meet with development programmes and national exigencies. This department also keeps Test Key arrangements used for transmitting the instructions by cable, as in cable transfers no signature of the remitting bank is possible. So messages are computed with a particular number known as code or cipher. This code or cipher is recomputed at the other centre on the basis of the test arrangements exchanged between the two banks. In foreign exchange, whatever the reason may be irrespective of the amount, the entire gamut is focused around the inward and outward remittances and so this section is of prime importance. The remittances are converted into local currency in case of inward remittances and in foreign currency in case of outward remittances at the prevailing rate of exchange on the date of each transaction or a forward exchange rate if exchange rate if exchange is already booked earlier. So, the remittance department has to keep a close contact with Dealers section, both for getting the rates and also advising them the funds position which changes from time to time due to the remittances flowing in either direction. 3. Import Section Import section can be sub-divided into import letters of credit both opening and payment thereof, issue of Bid guarantees, performance guarantees and guarantees to Government agencies for release of import consignment, import documents received on collection basis and imports on consignment basis. Import section has to keep in touch with latest developments in international markets as well as the rulesand regulations in force in various centers to take up the import business at right earnest without violating the rules and regulations. Both in developing and developed countries, there are Import and Export Trade Control Regulations and such regulations are enforced through a licensing procedure. Hence the Import section has to take care of the Import Trade Control Regulations as well as Exchange Control

Regulations before allowing import transactions to be put through. 4. Export Section The section deals with various exchange operations arising out of export trade. The principal functions of this sub-section are: (a) Advising and confirming letters of credit received from abroad: (b) Extending financial assistance to exporters as and when required. (c) Acting as an agent for collection on behalf of the clients; (d) Negotiation of export bills drawn under letters of Credit whereby the dealer acts as an agent of overseas bank and facilitates smooth function/operation of international trade; and (e) Acting as an authorized channel appointed by Central Banking Authority to receive the export proceeds. 5. Statistics Section This section collects the sales and purchase figures from various departments along with necessary exchange control forms, tabulates then and submits a periodical report by way of statements and returns to the Exchange Control Department of the Reserve Bank of India under whose authority it operates. This reports is also being submitted from time to time in one form or the other to the head office of the concerned bank to enable it to compile the overall position of the foreign exchange preferably of the bank as a whole.

Exchange Rate Mechanism in India

India is a founder member of the IMF. It followed the fixed parity system till the early 1970s as a result which the value of the rupee in terms of gold was originally fixed as the equivalent of 0.268601 gram of fine gold. In view of Indias long economic and political relations with England and membership of the sterling area from September 1939 to June 1972, the rupee was pegged to the pound sterling. The exchange rate was thus remained unchanged but the gold content of the rupee fell to 0.186621 gram. Again, with the devaluation of the Indian rupee in June 1996 the gold content fell further to 0.118489 gram. The following year, the pound was also devalued. This devaluation did have an impact on the rupee pound link, but the rupee

was kept stable in terms of the pound. The latter continued as an intervention currency. In August 1971 when the system of fixed parity was under a cloud, the rupee was briefly pegged to the US dollar at Rs. 7.50/US $ and this continued till December 1971. The peg to the dollar was not very effective as the pound sterling remained to continue as the intervention currency. In December 1971, the rupee returned to the sterling peg at a parity of Rs. 18.9677/ with of course , a margin of 2.2 S percent. After the Smithsonian arrangement had failed and the pound had began to float, the rupee tended to depreciate. The reserve Bank then had to delink it from the pound sterling in September 1975 and link it with a basket of five currencies; but the pound sterling was retained as the intervention currency for fixing the external value of the rupee. The weight of different currencies forming the basket remained confidential and the exchange rate continued to be administered. The administered rate did not keep pace with the growing rate of inflation and this resulted in a widening gap between the real and the nominal exchange rates that was more evident during the late 1980s and early 1990s. Thus, when economic reforms were initiated in the country, the rupee was depreciated by around 20 percent in two successive installments in the first weeks of July 1991. In absolute terms, depreciation occurred from Rs. 21.201/US $ to Rs. 25.80 /US $ From March 1992 a dual exchange rate system was introduced, in terms of which 40 percent of export earnings were to be converted at the official exchange rate prescribed by the Reserve Bank and the remaining 60 percent were to be converted at market determined rates. The US dollar was he intervention currency. From March 1993 the receipts on merchandise trade account and some of the items of invisible trade account came to be convertible entirely at the market determined rates on all items of current account. The adoption of the unified exchange rate system form March 1993 means adoption of a floating-rate regime, but it is a managed floating and the reserve Bank of India intervenes in the foreign exchange market in order to influence the value of the rupee. In the first two years, the value of the rupee remained stable but the onward, it has been depreciating despite RBIs intervention.

Factors Responsible for Premium i) Excess demand of forward currency ii) Higher Rate of Interest in centre home centre iii) Likely Appreciation of Spot Rates Discount i) Excess supply of forward currency ii) Higher Rate of Interest in Foreign

iii) Likely depreciation of Spot Rates


Indian Rupees to 1 USD




120 days

latest (Apr 13) 51.3029

lowest (Oct 31) 48.6951

highest (Dec 14) 53.9352


Indian Rupees to 1 GBP

120 days

latest (Apr 13) 81.7811

lowest (Feb 22) 77.0091

highest (Dec 14) 83.5257


Indian Rupees to 1 EUR

120 days

latest (Apr 13) 67.453

lowest (Feb 6) 63.978

highest (Nov 22) 70.89


Indian Rupees to 1 JPY

120 days

latest (Apr 13) 0.633422

lowest (Mar 14) 0.598599

highest (Jan 2) 0.692826


Indian Rupees to 1 CAD

120 days

latest (Apr 13) 51.617

lowest (Nov 4) 48.171

highest (Jan 3) 52.4903


Conversion i.n.r @ 13 febuary 2012

Currency American Dollar Argentine Peso Australian Dollar Botswana Pula Brazilian Real British Pound Brunei dollar Bulgarian Lev Canadian Dollar Chilean Peso Chinese Yuan Colombian Peso Croatian Kuna Danish Krone Euro Hong Kong Dollar Hungarian Forint Iceland Krona Indonesian Rupiah Israeli New Shekel Japanese Yen Kazakhstani Tenge Kuwaiti Dinar Latvian Lat Libyan Dinar Lithuanian Litas Malaysian Ringgit Mauritius Rupee Mexican Peso Nepalese Rupee New Zealand Dollar Norwegian Kroner Omani Rial Pakistan Rupee Philippine Peso Qatari Rial Romanian Leu Russian Ruble Saudi Riyal Singapore Dollar South African Rand



0.0194921 0.0856501 0.018739 0.144386 0.0356781 0.0122278 0.0243359 0.028995 0.0193735 9.44689 0.122854 34.6105 0.110807 0.110278 0.0148251 0.151284 4.40381 2.48768 178.13 0.0729974 1.57873 2.87781 0.0054207 0.0103554 0.0376665 0.0511881 0.0595925 0.56803 0.254863 1.60361 0.0234948 0.112656 0.0074947 1.76829 0.830918 0.0709512 0.0648747 0.575305 0.0730953 0.0242865 0.153959

51.3029 11.6754 53.3648 6.92589 28.0284 81.7811 41.0916 34.4886 51.617 0.105855 8.13973 0.028893 9.02467 9.06798 67.453 6.61007 0.227076 0.401982 0.005613 89 13.6991 0.633422 0.347486 184.476 96.5683 26.5488 19.5358 16.7806 1.76047 3.92368 0.623592 42.5627 8.87656 133.428 0.565519 1.20349 14.0942 15.4143 1.73821 13.6808 41.1751 6.49524

0.045249 South Korean Won Sri Lanka Rupee Swedish Krona Swiss Franc Taiwan Dollar Thai Baht Trinidad/Tobago Dollar Turkish Lira Venezuelan Bolivar 22.0997 2.50756 0.131862 0.0178153 0.574798 0.598993 0.124527 0.0348924 0.0836968 4 0.398794 7.58368 56.1314 1.73974 1.66947 8.03038 28.6596 11.9479

Market size and liquidity

Main foreign exchange market turnover, 19882007, measured in billions of USD.

Main foreign exchange market turnover, 19882007, measured in billions of USD.

The foreign exchange market is the most liquid financial market in the world. Traders

include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors. The average daily turnover in the global foreign exchange and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover wasUS$3.98 trillion in April 2010 (vs $1.7 trillion in 1998). Of this $3.98 trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards, swaps and other derivatives.

Trading in the United Kingdom accounted for 36.7% of the total, making it by far the most

important centre for foreign exchange trading. Trading in the United State s accounted for 17.9%, and Japan accounted for 6.2%.

Turnover of exchange-traded foreign exchange futures and options have grown rapidly in

recent years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. Foreign exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

Most developed countries permit the trading of derivative products (like futures and options

on futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Some governments of emerging economies do not allow foreign exchange derivative products on their exchanges because they have capital controls. The use of derivatives is growing in many emerging economies. Countries such as Korea, South Africa, and India have established currency futures exchanges, despite having some capital controls.

% of overall volume, May 2011



traders [7]

Ran Name k 1 2 3 4 5 6 7 8 9 10 Deutsche Bank Barclays Capital UBS AG Citi JPMorgan HSBC Royal Bank of Scotland Credit Suisse Goldman Sachs Morgan Stanley

Market share 15.64% 10.75% 10.59% 8.88% 6.43% 6.26% 6.20% 4.80% 4.13% 3.64%

Foreign exchange trading increased by 20% between April 2007 and April 2010 and has more than doubled since 2004. The increase in turnover is due to a number of factors: the growing importance of foreign exchange as an asset class, the increased trading activity of high-frequency traders, and the emergence of retail investors as an important market segment. The growth of electronic execution and the diverse selection of execution venues has lowered transaction costs, increased market liquidity, and attracted greater participation from many customer types. In particular, electronic trading via online portals has made it easier for retail traders to trade in the foreign exchange market. By 2010, retail trading is estimated to account for up to 10% of spot turnover, or $150 billion per day.

Foreign exchange is an over-the-counter market where brokers/dealers negotiate directly

with one another, so there is no central exchange or clearing house. The biggest geographic trading center is the United Kingdom, primarily London, which according to The City UK estimates has increased its share of global turnover in traditional transactions from 34.6% in April 2007 to 36.7% in April 2010. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. For instance, when the International Monetary Fund calculates

the value of its special drawing rights every day, they use the London market prices at noon that day.

Hedge funds as speculators

About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.

Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Some investment management firms also have more speculative specialist currency

overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. While the number of this type of specialist firms is quite small, many have a large value of assets under management), and hence can generate large trades.

Determinants of exchange rates

The following theories explain the fluctuations in exchange rates in a floating exchange rate regime (In a fixed exchange rate regime, rates are decided by its government):

International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world. Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit. Asset market model views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies. None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames (less than a few days) algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange. Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology.


Problems of Fluctuations in Forex Market

The exchange value of a currency, or the rate of exchange, fluctuates with changes in demand and supply. The factors which affect the demand for and the supply of a currency are many and varied. There are some factors which operate in the short period and have influence on day-to-day- fluctuations in rates of exchange. The commercial and financial relationship between trading countries is now extensive and payments on various accounts fall, due for early settlement. These payments on various accounts fall, due for early settlement. These payments constitute the shortterm demand and supply in regard to currencies. There are, however, changes in currency and credit conditions and political and industrial conditions which have their influence on exchange rates only in the long period. The factors affecting exchange rates may be summarized thus: 1. Short-term factors: (a) Commercial (b) Financial 2. Long-term factors: (a) Currency and credit conditions (b) Political and economic conditions

SHORT TERM FACTORS (a) Commercial factors

One of the important factors influencing the demand for and supply of currencies is trade in merchandise, i.e., imports and exports of goods. The demand for the currency of a country arises from exports of goods by the country B. An increase in a countrys imports due to an increase in demand, a reduction of tariffs, or an export-promotion drive by exporting countries raises the demand for and exchange value of currencies of exporting countries in the exchange market of the importing country. In other words, the exchange value of the currency of the exporting country falls. An increase in exports has the reverse effect. There are, in addition, many invisible items of payment which create debts

and, therefore, need for settlements through purchase and sale of exchange. The residents of a country have to pay and receive from foreigners for services of various kinds, such as transport, banking, insurance, etc. Premium, brokerage, commission and other risks of payments are made, or received by trading countries. Exports of equipment, enterprise and technical skill by advanced countries to underdeveloped countries has assumed considerable importance during recent years for which the exporting countries receive payments in the form of profits, dividends, foreign royalties and other charges. The effects of lactations in exchange rates are either favorable or adverse and healthy or unhealthy, depending upon the ultimate result and influence of the fluctuations on the balance of trade and payments position between the trading partners directly or indirectly. To avoid the adverse effects of rate of fluctuations and ultimate losses or gains to either of the trading partners, some of the countries, especially East European countries, have opted to enter into Bilateral Trade Agreements wherein the payments are settled through exchange of goods and services instead of making the payments in currencies of either of the countries. Such agreements avoid monetary transactions and the countries with lesser foreign exchange reserves can make the use of these scarce commodities to trade with other direct payment procedure countries. Summing up we can say that the demand for currency on trade account arises on account of the following factors: (i) The residents of the country have exported goods to other nations for which they have to receive payments. (ii) The shipping, banking and insurance companies of the country render services to other countries for which they receive remuneration. (iii) Entrepreneurs setting up business abroad, and supply technical personnel and managers receive profits and salaries. (iv) Tourists and students coming from abroad spend money in the country. (v) Besides the regular tourist traffic going from country to country only for tourist interests, here are certain groups traveling on cultural and exchange programmers under various government-sponsored delegations and private

visits to fiends and relatives staying in other countries also lead to the need of foreign exchange. In recent years, movement of individuals and groups on these accounts are on higher side, and the overall contribution of the exchanges effecting on these accounts are figuring remarkably in overall balance of payments position under the heading of private transfers Similarly factors which are responsible for supply of currency against a demand for foreign currencies are: (1) Imports from other countries. (2) Use of services by foreign shipping, banking, insurance and other services, for which payments are to be made. (3) Payments made as salaries and profits to foreigners not staying in the same country. (4) Residents of the country going as tourists abroad and for higher education in foreign universities and institutions spend money there.

(b) Financial Short-term Factors

International financial operations had important influence on exchange rates when movements of foreign capital and speculative dealings in foreign exchange are not controlled. The influence of short-term factors is much-less in present-day conditions. Financial operations include, among other transactions, short period movement of funds between two or more countries. If rates of interest are higher at one center than at another, the tendency would be for banks and other institutions at the place where the rates are low to use some of the funds for investment in bills the other center. In rates of interest in a country rise due to a rise in the central bank or some other reasons, there is a flow of short-term funds to the country and the demand for its currency and the exchange value of the currency rises in the exchange markets of other countries. The reverse happens if there is a fall in interest rates. Funds are also exported for short-term investment in other countries when the exchange value of the currency is expected to fall. This is purely a speculative operation.

Stock exchange transactions do play an important part in influencing exchange rates when imports and exports of capital are permitted. Residents of country sometimes buy a foreign currency in order to purchase securities on the stock exchanges of that country. These purchases may be for genuine investment or may be for speculative purposes. This is likely to happen when industrial prospects in the country of investment are bright and the prices of securities are expected to rise. In the event of poor economic and industrial outlook investments in that country are repatriated and the demand for its currency falls. Another financial factor is movement of funds from one center to another by banks. Banks maintain balances at different centers and the volume of maintaining the balances at a center depends on the economic and industrial state of the country. When the outlook in this regard is bright, remittances to the country increases and the banks acquires larger balances in that country. To pay for the foreign currency with increased demand, the value the currency changes the event of a poor outlook, banks shift their holdings to centers where the outlook is favorable and in such circumstances the exchange value of the currency depreciates. In recent years movement of funds from one country to another has been taking place on government account due to external assistance, aid and line of credits. Untied States particularly has been giving large financial assistance to other courtiers. This has increased the supply of funds in the aid-receiving countries. An exchange rate is sometimes affected by the disbursements and repatriation between countries for their debt settlements. When the economic outlook for a country has a stronger position in relation to others, and foreigners who have to make remittances to the country do so before the value of the currency rises higher. The demand for the currency rises further and its exchange value becomes more country is poor, the currency shows a downward trend in exchange markets. There is a tendency for the residents of the country to transfer their funds abroad and for foreigners to withdraw their funds. The currency, therefore, weakens further. Financial, operations also arise form what are known as Arbitrage Operations. Arbitrage means the simultaneous buying and selling of any commodity at two or more centers, used by a discrepancy in the price differentiation at different

places. Arbitrage in stocks or money or exchange on a international scale has an important influence n exchange rates. For example, taking price and exchange rates into account, an international operator may find that the price of a particular security which is bought on stock exchange at two centers in different countries differs. He, therefore, enters in a purchase deal at the center where the price is low and simultaneously enters into a sale deal at the one where the price is high. This necessitates remittance from the latter center to the former, causing the exchange rate to change in favor of the former and against the latter.

LONG TERM FACTORS (a) Currency and Credit Conditions

Any economic condition which causes the internal purchasing power of a currency to rise or fall eventually affects its exchange value. Such effects are frequently aggravated by the speculators in the exchange markets. Sometimes these operations curtail or diminish the effects of the economic factors. An expansion of currency circulation in a country raises the level of internal prices, or in other words, reduces the purchasing power of the currency and in the country. This has an adverse effect on export trade of the country and the demand for its currency in the exchange market tends to fall, causing fall in the exchange value of the currency. The speculators then sell the currency with the intention of buying it back when its price has gone down. This has a further lowering effect on the exchange value. This trend prevails till the effect of the internal rise in prices on exports is offset by the fall in the exchange value of the currency. A revival of a trade activity or an improvement in the investment climate in a country increases the demand for the countrys exports from rising further. A currency may be in demand as it may be used as reserve by central banks or is used for making internal payments. This is usually a currency which is easily convertible into other currencies. U.S. dollar is one such currency and its value could be maintained in spite of large supplies of dollars in the world market. British sterling has been convertible into other Sterling Area currencies and has been in use for

payments between countries of that area. Since 1958, the sterling has been made initially convertible into other currencies also and its demand has increased. This, therefore, been able to maintain its value in spite of payments deficits.

(b) Political and Economic Conditions

Political conditions in a country have an effect on the exchange market. A stable government and healthy economic and political conditions are factors which entourage foreign capital to flow into the country. The demand for the countrys currency strengthens its exchange value. Political unrest, on the other hand, causes and outflow of capital, weakening the currency externally. The current position and future outlook in the industrial field, the budgetary position of the government, and an overall economic situation have also important influences in the exchange market. The existence of industrial peace, stable level of wages and prices and high level of efficiency in production have a strengthening effect on the exchange value of the currency in the long period. S similar is the effect of a balanced budged. Conversely, industrial unrest, high cost of production and prolonged deficit financing having an adverse effect on the exchange value of the currency. The effects of economic and political factors on exchange rates are further accentuated by speculation. Speculation creates considerable uncertainty and disturbance in the exchange market.

Market psychology
Market psychology and trader perceptions influence the foreign exchange market in a variety of ways: Flights to quality: Unsettling international events can lead to a "flight to quality", a type of capital flight whereby investors move their assets to a perceived "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively

weaker counterparts. The U.S. dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty. Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends. "Buy the rumor, sell the fact": This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".] To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices. Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight. Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.

Financial instruments
Spot- Foreign exchange spot A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira, EURO and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a direct exchange between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.

Forward contract
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.

Foreign exchange swap

The most common type of forward transaction is the swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. A deposit is often required in order to hold the position open until the transaction is completed.

Currency future
Futures are standardized forward contracts and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Foreign exchange option

A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The options market is the deepest, largest and most liquid market for options of any kind in the world.


Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, economists including Milton Friedman have argued that speculators ultimately are a stabilizing influence on the market and perform the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do. Other economists such as Joseph Stiglitz consider this argument to be based more on politics and a free market philosophy than on economics. Large hedge funds and other well capitalized "position traders" are the main professional speculators. According to some economists, individual traders could act as "noise traders" and have a more destabilizing role than larger and better informed actors. Currency speculation is considered a highly suspect activity in many countries While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according to this view, it is simply gambling that often interferes with economic policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to raise interest rates for a few days to 500% per annum, and later to devalue the krona. Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of this view. He blamed the devaluation of the Malaysian ringgit in 1997 on George Soros and other speculators. Gregory J. Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit. In this view, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and foreign exchange speculators made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling, followed by an eventual, larger, collapse. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.

Hedging in Currency Futures Market

Tenders make use of the market for currency futures in order to hedge their foreign exchange risk. For instance suppose a French importer importing goods from Germany for DM 1.0 million needs this amount for making payment to the exporter . It will purchase DM at a future settlement date. By holding a futures contact, the importer does not have to worry about any change in the spot rate of the DM over time. On the other hand, if the French exported exports goods to a German firm and has to receive DM for the exports, the exporter would sell a DM futures contract. This way the exporter will be locking in the price of the export to be received in terms of DM. It will protect itself form the loss that may occur in case of depreciation of the DM over time.

Speculation With Currency Futures

Speculators make use of the currency futures for reaping profits. When they expect that the spot rate of a particular currency will move up beyond those mentioned in the currency futures contract, they buy currency futures denominated in that particular currency. At maturity, if their expectations come true, the difference in the sport rate and the rate mentioned in the futures contract will be the profit to be reaped by them. Suppose, the futures rate is US & 1.75/and the spot rate on maturity is expected to be US$ 1.76. If the speculator purchases 62,500at the rate of US1.75 (under the futures contract) and the expectation comes true and so sells that pound at the rate of US $1.76 in the spot market, the profit will be US $ (1.76-1.75)* 62,500 = US $625. In other words, the speculators buy currency futures in a currency when the future rate of that currency is expected to be greater than the currency futures rate. On the other hand, if the sport rate of a particular currency is expected to depreciate below the rate mentioned in the currency. For example, if the value of the pound is expected to drop to US $ 1.74 on the maturity date, the speculator will strike a currency futures deal to sell pounds. On the maturity date, it will sell 62,500 at US $ 1.75 and with the sale proceeds to be obtained in US dollars, it will buy pounds at the

spot rate. This way, it will make profits equal to US $ (1.75-1.740* 62,500 or US $ 625. It may be noted here that these transactions involve cost that is to be deducted from the gain. The transaction cost is very nominal for the locals, but is significant for the speculators.

Intra-currency Spread
Speculators can buy or sell futures of the same currency for two delivery dates if the rates for those two dates differ. This is known as intra currency spread. Suppose, sport rate is US$ 1.795/: the June-delivery rate is US$ 1.79/ and the September delivery rate is US $ 1.775/. If the speculator expects that the pound will depreciate more rapidly than exhibited by the futures rates, he will buy two futures in pounds for the above two dates. Prior to maturity, he will reverse the two contracts respectively, say, at US $ 1.78 and US $ 1.76. Now in the original contract, the price difference in the two different maturity contracts is US $ 1.79-1.775 = 0.015 while in the reverse contracts, the difference amounts to US $ 0.02. Since the difference in the price of the reverse contracts is greater than the difference in the price of the original contracts, the speculator makes profit amounting to US $ (0.020-0.015)* 62,500 = 312.5.

Inter-currency Spread
Besides the intra-currency spread, inter-currency spread is also used by the speculators. Such spread occurs when the deal involves purchase and sale of future contracts with the same delivery date but with two different underlying currencies. Suppose the speculator expects an appreciation of Canadian dollar relative to the British pound. HE WILL BUY Canadian dollar futures and sell pound futures. Before maturity, he will reverse the two contracts. If the price difference of the two reverse contracts is less than the price difference of the original contracts, the speculator will make a profit


Privilege of Non-execution of Contract Foreign currencies are traded in the market for currency options as well. The purpose is either the hedging of foreign exchange exposure or making of profits through speculation. As in currency forward and futures contracts the buyer of currency options possesses the right to buy or sell foreign currency after the lapse of specified period at a rate, determined on the day the contract is made. The currency options contract has a distinctive feature that is not found in a forward or futures contract. It is that the buyer of currency options has the freedom to exercise the option if the agreed-upon rate terms in his favor. If the rate does not turn in his favor, he can let the options expire. Thus the exercising of options in the buyers right but not his obligation. For this privilege, the buyer has to pay a premium to the option-seller. Suppose a person decides to acquire call options to buy Swiss francs at a price of US $ 0.70 along with a premium for US$ 0.02. On the maturity date, if spot rate of the Swiss franc is lower than the agreed upon rate, he will let the option expire because he will be able to buy it in the sport market at a cheaper rate. But if the sport rate is US $ 0.75 he will exercise the option because his cost of buying Swiss francs under the options contract (inclusive of premium) will be US $ 0.72, whereas he can sell his currency in the spot market at a higher rate and can thereby earn a profit.

Type of Options
Broadly speaking, there are two types of options. In a call option, the buyer of the option agrees to buy the underlying currency, while in a put option contract, the buyer of the option agrees to sell the underlying currency. The call and put options are also of two types. One, known as the European option, is exercised only on maturity. The other, the American option, may be exercised even before maturity. It is normally in the buyers interest to exercise the option before maturity and so American options command higher prices than European options.

In recent years, some more variants of options have become available. The first is, for example, known as a forward reversing option. In this case, a call option premium is paid only when the spot rate is below a specified level. The premium is quoted by the seller who charges the premium only when the options are not exercised. This way the buyer gets liberal terms. Secondly, there are preference options in which the buyer gets an additional privilege to designate the option either as a call option or as a put option. Though this privilege is exercised only after the lapse of a specified period. In the case of average rate options, it is the arithmetic average of the sport rate during the like of the option that is taken into account at maturity instead of the spot rate. This type of option enables the buyer to hedge a series of daily cash inflows over a given period in one single contract. If the average rate on maturity is lower than the strike price, the buyer gets the difference between the two. If the average rate is higher than the strike rate, the buyer lets the option expire. A look-back option gives the holder the right to purchase or sell foreign currency at the most favorable exchange rate realized over the life of the option. For example, the buyer of a call has the right to buy the underlying currency at the lowest exchange rate realized between the creation of the call and the expiry date. The buyer of a put option has the right to sell the underlying currency at the highest exchange rate during the life of the option. All this means that the strike rate in a look-back option is not known until the expiry date. Naturally, because of this specialty, the premium of a look-back option is normally higher than the premium of the traditional option. In a cylinder or tunnel option, two strike rates exist. When the spot rate is lower than the lower strike rate, the buyer has to pay the lower strike rate. He pays the higher strike rate if the spot rate is higher than the higher strike rate. If the sport rate is between the two strike rates, the buyer pays the spot rate. There are also barrier options. In the case of down-and-out option, the option expires automatically if the spot rate reaches a level mention ed in the contract. In a down-and-in option, option is activated only when the sport rate reaches a specified barrier within the expiry date. The basket option caters to buyers who are confronted

with foreign exchange risk in respect of many currencies. Hedging With Currency Options

(a) Hedging through purchase of option

In order to hedge their foreign exchange risks, if it is a direct quote, the importers buy a call option and the exporters buy a put option. We first take the case of an importer. Suppose and Indian firm is importing goods for 62,500 and the amount is to be paid after two months. If an appreciation in the pound is expected, the importer will buy a call option on it with maturity coinciding with the date of payment. If the strike price is Rs. 60.00/, the premium is Rs. 0.05 per pound and the spot price at maturity is Rs. 60.20/, the importer will exercise the option. It will have to pay Rs. 60.00*62,500+3,125 = 3,753,123. If the importer had not opted for an option, it would have had to pay Rs. 62,500*60.20 = 3,762,500. Buying of the call option reduces the importers obligation by Rs.3,762,500-3,753,125 =9375. If on the other hand, the pound falls to Rs.59.80, the importer will not exercise the option since his obligation will be lower even after paying the premium. Buying of currency option is preferred only when strong volatility in exchange rate is expected and volatility is only marginal, forward market hedging is preferred. Suppose, in the earlier example, the pound appreciates to only Rs. 60.04 or depreciates to only Rs. 59.97, the amount of premium paid by the importer will be more than the benefit form hedging through purchase of options. There will then be net positive cost of hedging through buying of option. The exporter buys a put option. Suppose an Indian exporter exports goods for 62,500. It fears a depreciation of pound within two months when payments are to be received. In order to avoid the risk, it will buy a put option for selling he pound for a two-month maturity. Suppose the strike rate is Rs. 60.00 the premium is Rs. 0.05 and the spot rate at maturity is Rs. 59.80. In case of the hedge, it will receive Rs. 62,500*60.00-3,125 = 3,746,875. In the absence of a hedge, it will receive only Rs. 3,737,500. This means buying of a put option helps

increase the exporters earnings, or reduces its exposure, by Rs. 3,746,875 3,737,500 = 9,375.

(b) Hedging through Selling of Options

Hedging through selling of options is advised when volatility in exchange rate is expected to be only marginal. The importer sells a put option and the exporter sells a call option. Let us first take the case of importers. Suppose an Indian importer imports for 62,500. It fears an appreciation in the pound and so it sells a put option on the pound at a strike price of Rs. 60.00/ and at a premium of Rs. 0.15 per pound. If the spot price at maturity goes up to Rs. 60.05 the buyer of the option will not exercise the option. The importer as a seller of the put option will receive the premium of Rs. 9,375 which it would not have received if it had not bought the option. If the spot price at maturity falls to Rs. 59.95 the buyer of the option will exercise the option. But in that case, the importer will have to pay to the buyer Rs. 3,750,000-9,375=3,740,625. When there is no hedging through selling of a put option, the importer, will gave to pay Rs 3,746,875. Thus the importer reduces its risk through the sale of put options. The exporter sell the call option. If an Indian exporter exports for 62,500 and fears that pound will depreciate and sells a call option on the pound at a strike price of Rs. 60.00 at a premium of Rs.0.15 per pound. If the spot rate at maturity really falls to Rs. 59.95, the buyer of the option will not exercise the option. The exporter being the seller of the call option will get Rs. 93,95 as the premium. Its total receipt will be Rs. 62,500*59.95 =9,375 = 3,756,250. In the case of no sale of a call option, the total receipt 9from the importer) will be only Rs. 3,746,875.

Risk aversion

Fig. Chart showing MSCI World Index of Equities fell while the US Dollar Index rose.

Risk aversion is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens which may affect market conditions. This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty. In the context of the foreign exchange market, traders liquidate their positions in various currencies to take up positions in safe-haven currencies, such as the US Dollar. Sometimes, the choice of a safe haven currency is more of a choice based on prevailing sentiments rather than one of economic statistics. An example would be the Financial Crisis of 2008. The value of equities across the world fell while the US Dollar strengthened (see Fig.). This happened despite the strong focus of the crisis in the USA.


With the passage of time and with the advent of globalization, the Indian forex market has experienced sea changes. The adoption of the unified exchange rate system from March 1993 means adoption of a floating-rate regime, but it is a managed floating and the Reserve Bank of India intervenes in the foreign exchange market in order to influence the value of the rupee. In the first two years, the value of the rupee remained stable but then onward, it has been depreciating despite RBIs

intervention. The foreign exchange market again came under pressure in August 1998, reflecting the adverse sentiment on account of the deepening of financial crisis in Russia and fears of the Chinese renminbi devaluation, resulting in a depreciation of the rupee to Rs. 43.42 on August 19, 1998. Authorized dealers in foreign exchange do a small volume of business with travelers going or coming from other countries of selling and buying foreign currency notes and coins. Besides the authorized dealers, there are also money changers specially authorized to deal in foreign currencies. The Indian foreign exchange market, broadly concentrated in big cities, is a three-tier market. The first tier covers the transactions between the Reserve Bank and the authorized dealers (Ads). As per the Foreign Exchange Regulation Act, the responsibility and authority of foreign exchange is vested with the RBI. It is the apex body in this area and for its own convenience, has delegated its responsibility of foreign exchange transaction functions to Ads, primarily the scheduled commercial banks. They formed the Foreign Exchange Dealers Association of India which frames rules regarding the conduct of business, coordinates with the RBI in the proper administration of foreign exchange control and acts as a clearing house for information among Ads. The exchange value of a currency, or the rate of exchange, fluctuates with changes in demand and supply. The factors which affect the demand for and the supply of a currency are many and varied. There are some factors which operate in the short period and have influence on day-to-day fluctuations in rates of exchange. The commercial and financial relationship between trading countries is now extensive and payments on various accounts fall, due for early settlement. These payments constitute the short-term demand and supply in regard to currencies. There are, however, changes in currency and credit conditions and political and industrial conditions which have their influence on exchange rates only in the long period. In recent years financial markets have developed many new products whose popularity has become phenomenal. Measured in terms of trading volume, the growth of these products-principally futures and options contracts for physicals commodities have only recently attracted internet. Traders make use of the market for currency

futures in order to hedge their foreign exchange risk. Speculators make use of the currency futures for reaping profits. When they expect that the sport rate of a particular currency will move up beyond those mentioned in the currency futures contract, they buy currency futures denominated in that particular currency. At maturity, if their expectations come true, the difference in the sport rate and the rate mentioned in the futures contract will be the profit to be reaped by them. Foreign currencies are traded in the market for currency options as well. The purpose is either the hedging of foreign exchange exposure or making of profits through speculation. Broadly speaking, there are two types of options. In a call option, the buyer of the option agrees to buy the underlying currency, while in a put option contract the buyer of the option agrees to sell the underlying currency. The need of the hour is to have a complete control of market by the RBI and Govt. of India regarding the convertibility of rupee so that the story of currency of the South-East Asia could not be repeated and the stability of rupee could also be maintained to give boost and confidence to our international trade.

1) To avoid the adverse effects of rate of fluctuations and ultimate losses or gains to either of the trading partners, India should enter into Bilateral Trade Agreements wherein the payments are settled through exchange of goods and services instead of making the payments in currencies of either of the countries. 2) Shares purchased by foreign citizens should be controlled and checked because this is more for speculative purposes. 3) As the prices of currency differ in different markets, it promotes arbitrage operations of the currency so focus should be paid on maintaining similar rates around the world. 4) Circulation of the currency in the country should be limited as it decreases the purchasing power of the currency and which has a adverse effect on

exports of the country. 5) In India industrial unrest, high cost of production and prolonged deficit financing are causing adverse effect on exchange value of the currency which needs to be removed. 6) Incremental CRR of 10% of NRER and NR accounts should be reduced to segment supply of foreign exchange in the country.


The exchange rate remained stable in the period that followed the institution of a market-based exchange rate mechanism in March 1993, even though liberalization of transactions during this period helped in a quick transition to currency account convertibility. During 1992-93 or 1994-95, stability in the currency market was supported by the Reserve Banks policy of absorbing the excess supply resulting from strong capital inflows. As a result, all segments of financial market witnessed easy liquidity conditions as a result. The Reserve Bank divested net domestic assets (essentially through open market, including repo operations) to maintain monetary stability, while modulation interest rates in the money market. The domestic currency came under minor pressure during November 1994 and in mid March1995, but stability was quickly restored. The latter half of the nineties, however, witnessed some episodes of volatility in the money and the foreign exchange market which underscored the gradual integration of the domestic money market and the foreign exchange market. Asset prices responded to deregulation of interest rates, two-way capital movements, changes in macroeconomic conditions and general sentiments that were impacted by economic and non-economic factors. The South-East Asian crises necessitated twin-pronged policy action. The Reserve Bank attempted to mitigate excess demand conditions in the foreign exchange market. In also moved to siphon off excess liquidity from the system in order to reduce the scope for arbitrage between the easy money market and the volatile foreign exchange market. This helped contain the impact of contagion. Foreign currency sales in the third quarter of1997-98 (which resulted in a decline of Ks. 7,150 crore in the RBIs NFA-adjusted for revaluation)

were undertaken to curb the volatility in the exchange rate. Measures, such as removal of incremental CRR of10.0 per cent on NRER and NR (NR) deposits defective December 6, 1997, were also undertaken to segment supply of foreign currency. With a view to containing demand, the interest rate on post-shipment export credit in rupees beyond 90 days and up to six months was raised from 13.0 percent to15.0 percent and an interest rate surcharge was introduced on import finance as leads and lags in import payments and export realizations widened. The restoration of stability in the Indian currency market was primarily the result of a credible stance to arrest volatility caused by speculation and keep rupee stable and the gradual moderation of pressures in the East Asian currency markets in end-January 1998. As the rupee adjusted downwards smoothly in the months that followed aided by a turnaround in capital inflows, the Reserve Bank eased some of the monetary measures clamed earlier in the face of volatility. Export credit refinance limits were restored in April 1998. The foreign exchange market saw the return of excess demand conditions in mid May 1998, in reaction to the Impending sanctions, resulting in the exchange rate weakening from Rs. 39.73 per US dollar at the beginning of May to Rs. 42.38 by June 11, 1998. The Reserve Bank sold foreign currency in response to excess demand in the foreign exchange market, depleting its NFA by Rs. 6,597 crore (adjusted for revaluation). Net merchant forward sales jumped to US $ 5,498 million, resulting in a sharp increase in the one-month forward premium to 9.59 percent in June 1998 from 3.67 percent in April 1998. The Reserve Bank announced a package of policy measures on June 11, 1998 to contain volatility in the foreign exchange market. These included: (i) Announcement of the Reserve Banks readiness to sell foreign exchange to meet demand-supply mismatches. (ii) Advising importers as well as banks to monitor their credit utilization so as to meet only genuine foreign exchange demand and discourage any undue buildup of inventory. (iii) Allowing banks/Ads acting on behalf of FIIs to approach the Reserve Bank for direct purchase of foreign exchange and

(iv) Advising banks to charge a spread of not more than 1.5 percentage points above the LIBOR on export credit in foreign currency as against the earlier norm of 2.0-2.5 percentage points. Stability returned briefly but pressures renewed by the end of the month. The rupee touched Rs. 42.92 per US dollar on June 23, 1998 but firmed up at end-June 1998 to Rs. 42.47 per US as stability was restored with the sentiment improving in response to the Reserve Banks policy response and favorable politician developments. The foreign exchange market again came under pressure in August 1998, reflecting the adverse sentiment on account of the deepening of financial crisis in Russia and the fears of the Chinese renminbi devaluation, resulting in a depreciation of the rupee of Rs,. 43.42 on August 19,1998. This was reflected in net spot and forward merchant sales in the foreign exchange market of US $ 1255 million and US $ 2,225 million. The one-month forward premia, which had softened to 5.84 percent in July firmed back to 9.58 percent in August 1998. The Reserve Bank announced a second package of measures in order to prevent speculative pressures on the foreign exchange market, which, inter alia, included: (i) A hike in the CRR from 10 percent to 11 percent. (ii) Increase in repo rate from 5 per cent to 8 percent, and (iii) Withdrawal of the facility of rebooking of the cancelled contracts for Imports and splitting forward and spot legs for a commitment. A significant contribution in this phase was made by the mobilization of US $4.2 billion through Resurgent India Bonds (RIBs) that helped in an accretion of US $ 3.7 billion to the foreign exchange reserves. The rupee strengthened to Rs. 42.55 per US dollar by end-August and further to Rs. 42.59 per US dollar by end-September. The one-month forward premia declined to 7.42 percent in September and to 4.96 percent by December 1998. Liquidity conditions tightened with the return of excess demand conditions in the foreign exchange market during May-June 1998 but eased after the Reserve Bank announced its intention to limit the impact of the large Government borrowing programm by accepting private placement of Government securities when bids were

unreasonably high and releasing them to the foreign exchange market as and when liquidity conditions improved. RBIs also helped in reviving the market interest in the Government paper. March 1999 saw the revival in capital inflows with the Reserve Banks NFA recording a orderly conditions in the foreign exchange market/the Reserve Bank announced the reduction in the Bank Rate by one percentage point to 8 percent and the repo rate by 2 percentage point to 6 percent effective March 2, 1999 and lowered the reserve requirements (by 50 basis points each effective March 13, 1999 and May 8, 1999. The foreign exchange market witnessed a degree of volatility during end-MayJune 1999 and August 1999. Effects of policy pronouncements backed by sale of foreign exchange of Rs. 2242 crore (adjusted for revaluation were able to restore stability in the foreign exchange market. The Reserve Bank reiterated its policy of meeting temporary mismatches in the foreign exchange market, after the rupee depreciated to Rs. 43.39 per US dollar by June 25, 1999 in order to restore orderly conditions in the foreign exchange market as the demand supply gap widened in endAugust 1999 the Reserve Bank indicated its readiness to meet fully/partly foreign exchange requirements on account of crude oil imports. The exchange rate of the rupee against the US dollar continued to be broadly market determined. During 1999-2000, the exchange rate market displayed reasonable stability, with the rupee depreciating by about 2.9 per cent from the annual average of Rs. 42.07 per US dollar in 1998-99 to Rs. 43.33 in 1999-2000. In contrast the year 2000-2001 witnessed significant downward pressures on the rupee-dollar rate from mid-May 2000. The forex markets were affected by considerable uncertainly with the rupee depreciating by 6.7 percent between end-April and end-October 2000 from Rs. 43.665 per US dollar to Rs. 46.775. Since November 2000, the situation has shown large improvement and the forex market have been relatively stable. At the end of January 2001, the exchange rate of the rupee was Rs. 46.415 per US dollar showing a depreciation of 6.1 percent, compared with the rate of Rs. 43.605 at the end of March 2000. The exchange rate remained stable in the period that followed the institution of a market-based exchange rate mechanism in March 1993, even though liberalization

of transactions during this period helped in a quick transition to current account convertibility. During 1992-93 to 1994-95, stability in the currency market was supported by the Reserve Banks policy of absorbing the excess supply resulting from strong capital inflows. As a result, all segments of financial market witnessed easy liquidity condition as a result. The Reverse Bank divested net domestic assets (essentially through open market, including repo operations) to maintain monetary stability, while modulating interest rates in the money market. The domestic currency accretion of Rs. 8008 crore 9adjusted for revaluation). With the return of came under minor pressure during November 1994 and in mid-March 1995, but stability was quickly restored. The latter half of the nineties, however, witnessed some episodes of volatility in the money and the foreign exchange market which underscored the gradual integration of the domestic money market and the foreign exchange market. Asset prices responded to deregulation of interest rates, two-way capital movements, changes in macroeconomic conditions and general sentiments that were impacted by economic and non-economic factors. The foreign exchange reserves of the country consist of foreign currency assets held by the RBI, gold holding of the RBI and SDRs. Foreign currency assets at the end of March 2000 amounted to US $ 35.06 billion, showing an increase of US % 5.54billion during 1999-2000. During the first seven months of 2000-01, these assets had declined by about US $ 2.96 billion to US $ 32.09 billion at the end of October 2000, reflecting steps (sale of foreign exchange) taken by the RBI to meet part of the excess demand in the foreign exchange market created by the surge in Indias oil import bill because of the near tripling of international oil prices within a year so. An essential component of strategy by to meet the challenge of this extraordinary increase in oil import bill was to arrange exceptional BOP financing in the form of India Millennium Deposits (IMD) floated by the State Bank of India. As a result foreign exchange increased and thereby the foreign currency assets of the RBI reached an all the time high level of US $ 38.36 billion, showing an increase of US $ 3.30 billion during 2000-01. While gold holdings of RBI were 357.8 tonnes (same as at end-March 2000), the value of these holdings declined to US $ 2751 million at end-January, 2001 US $ 2974 million at end-March2000, reflecting re-valuation losses. Total foreign exchange reserves

(including gold and SDRs) at end-January, 2001 amounted to US $ 41.12 billion, providing cover for about 8 months of estimated imports in 2000-01.

1. Rajwade , A.V., RBI circulations, third edition, Himalaya Publishing House, New Delhi. 2. Andley and Mattoo, Principles of Foreign Exchange, second revised edition, Sultan Chand and Sons, New Delhi. 3. Bhalla, V.K., International Financial Management, sixth edition, Kalyani Publishers, New Delhi. 4. Hull, John, Option and Future, Prentice Hall of India, twelfth edition, New Delhi. 5. Pandey, I.M., International Financial Management, Kalyani Publichers, New Delhi. 6. Derivatives, A text book circulated by National Stock Exchange, New Delhi. 7. Shapiro, Carland R. Varian Information on forex market Harvard Business School. 8. If Forex Marketreally flourishing? Business Today, December 31issue. 9. Business Worlds January 11 issue title The past and future of forex market of India. 10. Business & Economys July 23 issue named Winning in foreign exchange market. 11 . The Hindus article on 11thFebruary titled What effective foreign exchange markets really do.