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Exchange Rate Management

The document discusses exchange rate management, defining the rate of exchange as the value at which currencies are exchanged and outlining various types of exchange rates, including spot and forward rates. It explains how exchange rates are determined by the interaction of demand and supply for foreign exchange, influenced by factors such as international trade and government policies. Additionally, it details the role of the Reserve Bank of India (RBI) in managing exchange rates, including its objectives and responsibilities under the Foreign Exchange Regulation Act (FERA).

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2 views

Exchange Rate Management

The document discusses exchange rate management, defining the rate of exchange as the value at which currencies are exchanged and outlining various types of exchange rates, including spot and forward rates. It explains how exchange rates are determined by the interaction of demand and supply for foreign exchange, influenced by factors such as international trade and government policies. Additionally, it details the role of the Reserve Bank of India (RBI) in managing exchange rates, including its objectives and responsibilities under the Foreign Exchange Regulation Act (FERA).

Uploaded by

krishnadevvishwakarmakd
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Exchange Rate Management

Rate of Exchange –
*The rate at which the currencies of two nations
are exchanged for each other
*It is a value or price of a country’s currency
expressed in terms of a foreign currency
*Example –
If 1 US dollar is exchanged for Rs. 70, then the
foreign exchange rate is 1 US $ = Rs. 70
*There is a variety of exchange rates -
1. Spot Rate
2. Sight Rate – In case of foreign currency bills
3. Long Rate – May be one month rate or month’s
rate
4. Forward Exchange Rate – For future contracts
*The market mainly deals with two types of
exchange rates –
1.Spot Rate
2.Forward Rate
Exchange Rate Determination
Exchange Rate Determination -
*The rate of exchange in the foreign exchange
market will be determined by the interaction
between the demand for foreign exchange &
the supply of foreign exchange
Demand for Foreign Exchange
*It is influenced by –
 The country’s level of development
 Growth rate
 International trade
 Govt. polices
*The important factors that generate demand for
foreign exchange are –
1.Import of Goods –
*To meet domestic demand
*To take advantage of cost differences
*Emerging economies
2.Import of Services –
*The development of communication
technology
*Countries import –
 Tourism
 Transport
 Banking
 Insurance
 Communication
 Education
 Professional Services
3.Unilateral Payments -
*Not correspond to the purchase of any goods,
services or assets
* These includes –
 Donations
 Gifts
 Returning of incomes like –
 Profits
 Dividends
 Interest to creditor countries
 Foreign aid & assistance given by the Govt. of a
country to other countries
4.Export of Capital -
*Demand for –
 Repayment of debts
 Purchase of assets
 Investment in financial assets in foreign
countries
 FDI
 Lending to foreign nations
5.Future Expectations
 To protect themselves in fluctuations
*Speculators Demand for –
 To make profit by selling the currencies at a
higher rate in the future
*Diagram -
*Diagram -

Foreign Exchange Y
Rate (in Rs.)

R
R1 Df

O Q Q1 X
Demand for Foreign Exchange (in US $)
*In this diagram –
The total demand for foreign exchange is inversely
related to its rate
Supply of Foreign Exchange
The important factors responsible for the supply
are –
1.Export of Goods –
*Supply of foreign exchange is influenced by –
 The volume of exports
 The prices of the exported goods
2.Export of Services –
 The volume of exports
 The prices of the exported services
*Many countries have been earning larger part of
their foreign exchange from this source
*Example- India
3.Unilateral Receipts –
*Without corresponding sale of any goods,
services or assets
*These includes –
 Donations
 Gifts
 Aid received by the residents & Govt.
 Profits
 Dividends
 Interest from abroad etc.
4.Import of Capital –
*Due to –
 External borrowings
 FDI
*It is highly influenced by the Govt. policies
5.Future Expectations –
*Sell of foreign currencies by speculators
*Speculation is motivated by future price
expectation
Diagram –
The total supply of foreign exchange is directly
related to its price, i.e., the exchange rate
Y
Foreign Exchange Sr
Rate (in Rs.) R1

O Q Q1 X
Supply of Foreign Exchange(in US $)
In this diagram –
*The supply is directly related to the rate or price
*The supply curve of foreign exchange like any
other supply curve, slopes upwards
Determination of Equilibrium Exchange Rate
*The rate of exchange is the function of demand &
supply of foreign exchange
*Symbolically
R = f(D,S)
*It is determined by the interaction between
demand & supply of foreign exchange
*We can explain it with the help of diagram –
 In this diagram the demand curve(D-D) & supply
curve (S-S) intersect at point ‘E’(equilibrium
point)
 O-R is the equilibrium rate of exchange
 & O-Q shows the equal quantity of demanded &
supplied of foreign exchange
 At O-R1, supply exceeds demand & the rate of
exchange would be brought down to O-R
Foreign Exchange Rate (in Rs.)
S
R1 D (S > D)

R E
R2 (D > S) D
S

Demand & Supply of Foreign Exchange (in$)


 At O-R2, demand exceeds supply, & the rate of
exchange would pushed up to O-R
*Thus the forces of demand & supply would
determine the equilibrium rate of exchange
Role of RBI in Exchange Rate Management/
RBI Intervention & Exchange Rate Management
*The Exchange Control Department of RBI was set
up in 1939
*& the Foreign Exchange Regulation Act (FERA)
was passed in 1947
*This Act came in force on 1st Jan. 1974
*The Act empowered the exchange rights to –
 Central Govt.
 & RBI
Main Objectives of RBI in Indian FEM –
1.To maintain stability in exchange rates
2.To conserve scarce foreign exchange reserves for
essential purposes
3.To develop domestic industry
4.To promote economic development by restricting
imports and encouraging exports
Role of RBI in the FEM-
*It is revealed by the provisions of FERA
1.Administrative Authority -
*IRB is the administrative authority for exchange
control in India
*The RBI has rights to issue licences to those who
are involved in foreign exchange transactions
2.Appoinment of Authorised Dealers –
*It has appointed a number of authorised dealers
*It has issued licences to many commercial banks
& money exchangers’ to act as authorised dealers
3.Issue of Directions –
*The RBI issues directions to authorised dealers,
relating to –
 imports & exports
 Capital transfers
 Transfer of investment incomes
4.Fixation of Exchange Rates –
*The RBI has the responsibility of fixing the
exchange value of the home currency in term of
other currencies
5.Controlling Import Trade –
*Imports are permitted only against proper licenses
& the necessary foreign exchange is released by
the RBI
6.Controlling Export Trade –
*It controls in collaboration with authorities &
authorised dealers
*Payments for exports must be received only by
the approved method recognised by the RBI
7.Controlling Foreign Trade –
*It comes under visible items
*Indian residents can get foreign exchange released
from RBI up to a specified amount for travel
abroad through proper application

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