PRESENTATION ON

EXCHANGE RATE

Exchange Rates

What is Exchange Rate ?

In finance, An Exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one countrys currency in terms of another currency

For Example, An Interbank exchange rate of 50.60 indian rupee to equal to 1 US$ (United Stated dollar) or that Rs. 50.60 will be exchanged for each 1(US$) At Present, US $ 1 = Rs.50.60 This rate is the conversion rate of every US $ 1 to Rs. 50.60

Buying & Selling Rates

In the retail currency exchange market a different buying rate and selling rate will be quoted by money dealers which means most trades are to be done from the local currency through buying & selling rates. Buying rate :-The buying rate is the rate at which money dealers will buy foreign currency Selling rate :- and the selling rate is the rate at which they will sell the currency.

Factors Determining Exchange Rates

(a) Fundamental Reasons: - Balance of Payment surplus leads to stronger currency. - Economic Growth Rates High/Low growth rate. - Fiscal / Monetary Policy- deficit financing leads to depreciation of currency. - Interest Rates currency with higher interest will appreciate in the short term. - Political Issues Political stability leads to stable rates (b). Technical Reasons - Government Control can lead to unrealistic value. - Free flow of Capital from lower interest rate to higher interest rates. (c). Speculation higher the speculation higher the volatility in rates ).

Exchange Rates Regimes

There have been many currency arrangements over the last few centuries Broadly speaking they can be divided into two: Fixed exchange rates Flexible exchange rates Each system has its strengths and weaknesses

Fixed Exchange Rates

The government fixes the exchange rate either with an important reference with other currency But the exchange rate doesnt fluctuate according to demand and supply. Instead the central bank interviews the foreign exchange market to maintain the fixed rates In addition foreign exchange controls may be used to allocate foreign exchange rates

Advantages
A fixed exchange rate reduces exchange risk and the interruption, caused by sudden exchange rate movements By anchoring itself to a more reputable currency, the government can commit to following a sound monetary policy This in turn will ideally lead to lower interest rates

Problems
A fixed exchange rate will make the currency vulnerable to a speculative attack. A fixed exchange rate may encourage too much borrowing in foreign-currency debt For Example:- In East Asian crisis The rationing of foreign exchange rates which lead to inefficiency in the market and corruption

Flexible Exchange Rates

In a flexible exchange rate, the exchange rate is set by demand and supply in the foreign exchange markets But There is no intervention of central bank or by the government

Benefits
The benefits of a flexible exchange rate is that it preserves the freedom of the central bank to conduct monetary policy In fact under flexible exchange rates monetary policy will be extra effective because of the effect of capital movements on the exchange rate For example. Suppose a government wants to stimulate the economy, it will lower the interest rates which will lead to a currency depreciation which will further increase to the demand & supply in market.

Problems
Exchange rate appreciation may lead to an uncompetitive manufacturing sector Flexible exchange rates may lead to increase in the transaction costs for international business

Indian policy
India is not fully open to capital flows While India does try to maintain an independent monetary policy, it is not the only tool in controlling inflation. Fiscal policy and direct controls are also important India has a managed to choose a hybrid policy which tries to avoid inflation

Conclusion
Both fixed and flexible exchange rates have their strengths and weaknesses. Governments have to choose the best exchange rate regime according to governments future goals & policies with keeping in mind the fundamentals of exchange rates.