59335036 summer project report on currency market

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A Study

on

IMPACT OF CURRENCY MARKET IN INDIAN ECONOMY

Summer Project Report

Submitted

In the partial fulfillment of the Degree of

Master of Business Administration

Semester-II

By

NITISH PATEL 12.

Under the Guidance of:

Pro. NIKI SANGHVI

CENTER FOR MANAGEMENT STUDIES

Submitted To:

CENTER FOR MANAGEMENT STUDIES

Ganpat University,

Kherva.

(2010-2012)


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CERTIFICATE BY THE GUIDE

This is to certify that the contents of this report entitled IMPACT OF CURRENCY

MARKET IN INDIAN ECONOMY by Nitish Patel, 12 submitted to Center for

Management Studies for the Award of Master of Business Administration (MBA Sem-II) is

original research work carried out by him under my supervision.

This report has not been submitted either partly or fully to any other University or Institute

for award of any degree or diploma.

Date:

Place:

Pro. Niki Sanghvi.

Centre for Management Studies,

Ganpat University,

Ahmadabad.

i


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CERTIFICATE BY THE MENTOR

This is to certify that the contents of this report entitled IMPACT OF CURRENCY

MARKET IN INDIAN ECONOMY by Nitish Patel, 12 submitted to Center for

Management Studies for the Award of Master of Business Administration (MBA Sem-II) is

original research work carried out by him under my mentoring. I, hereby certify the

authenticity of the data and facts mentioned in the report.

This report has not been submitted either partly or fully to any other University or Institute

for award of any degree or diploma.

Date :

Place :

ii


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CANDIDATES STATEMENT

I hereby declare that the work incorporated in this report entitled IMPACT OF

CURRENCY MARKET IN INDIAN ECONOMY in partial fulfillment of the

requirements for the award of Master of Business Administration (Sem.- II) is the outcome of

original study undertaken by me and it has not been submitted earlier to any other University

or Institution for the award of any Degree or Diploma.

Date:

Place:

Nitish Patel

iii


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Preface

As a Part ofMBA Program, Student has to pursue a project duly approved by the Faculty of

Concerned area. I had the privilege of undertaking the project on Impact of Currency

Market in Indian Economyat Religare Securities Limited. Main aim of the Project is to

find out the factors which impact on Indian economy of currency market of glob & India.

The foreign exchange trading introduced in India since 2008. There are several products

traded in forex market. As far as the study is consent the report is mainly focusing on the

currency market in India. There are two exchanges MCX-SX and NSE for currency trading in

India. There are four main currency pairs been traded in India are USD, EURO, GBP and

JPY. There is major four ways to invest in or we can say financial instrument to invest in

currency are spot, forward, swap, future and option.

There are mainly three factors which impact the currency market are economic, political and

market physiology. Foreign exchange reserves in a strict sense are only the

foreign currency deposits and bonds held by central banks and monetary authorities. These

are assets of the central bank held in different reserve currencies, mostly the US dollar, and to

a lesser extent the euro, the UK pound, and the Japanese yen, and used to back its liabilities,

the impact on any economy can be measured by analyzing the GDP, GNP, Import and export

growth of the country and additionally the foreign reserve of the country.

The report contains the market research of currency investors as in-depth interview with

questioner. This Project work is divided into following parts which are as under.

1. Objective of the Study

2. Limitations of the Study3. Research Methodology.

4. To Understand Global Forex Market

5. To Understand Indian Forex Market

6. To Study Indian Economy

7. Data analysis & Interpretation

7. Conclusion

9. Annexure

10. Bibliography


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Acknowledgement

I am thankful to Mr. Siddharth Doshi (Branch Manager) and the management of Religare

securities limited for permitting me to go through my summer training.

First and for most I would like to thank my company guide Mr. Nishank Patel ( Sales

Manager) for his constant encouragement, guidance and advice at every stage of my training.

I would like to thank Mr. Pratik Adhvayu (Relationship Manager), Mr. Sameer Pandya

(Relationship Manager), Mr. Ritesh Panchal (Dealer). This project would not have been

successfully completed without their great support.

I am very much thankful to Center for Management Studies, Ganpat University for their

excellent guidance, support and appreciation and also provided me with this great opportunity

to work in such a reputed organization.

I express my sincere thanks to Mr. M. Sharma (chancellor), CA. Ujal Mehta (central

coordinator), Dr. Vipul Patel (coordinator) and a sincere thanks to Prof. Niki Sanghvi, Center

for Management Studies, Ganpat University, Ahmadabad, who helped me in understanding

the project and the implementation of the same. Her suggestions really helped me think on a

broad perspective and give me motivation to do my best. I would again like to thank Center

for Management, Ganpat University, Ahmadabad for helping and supporting me for my

Summer Internship Program at RELIGARE SECURITIES LIMITED.

Date:

Place: - Nitish Patel


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Table ofContent

Chapter Particulars Page no.

Certificate By the Guide I

Certificate by Mentor II

Candidates Statement III

Preface IV

Acknowledgments V

Table of content VI

List of Tables VIII

List of Figures & Graphs IX

Objective & limitations of the study X

Chapter 1 Introduction 1

Chapter 2 Company Profile 2

2.1. introduction of the company 2

2.2. Religare Securities Limited 4

2.3. Religare securities offering different services. 5

2.4. Group of companies 6

2.5. General information 7

Chapter 3 Research Methodology 8

3.1 Research Design 8

3.2. Define the target population 10

3.3. The six W 11

Chapter 4 Foreign Exchange Markets in India 12

4.1. Market Size and liquidity 14

4.2. Market participants 16

4.3. Trading characteristics 20

4.4. Determinants of FX rates 21

4.5. Financial instruments 24

4.6. Speculation 25

4.7. Foreign exchange reserves 26

Chapter 5 Economy of India 31

5.1. Post-liberalization period (since 1991) 32


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5.2. Sectors 33

5.3. External trade and investment 36

5.4. Indian currency exchange 39

5.5. Foreign Exchange Department of RBI 48

5.6. FEMA Rules & Policies 49

Chapter 6 Impact of currency market in Indian economy 50

6.1. GDP & GNP 50

6.2. Exports & Imports in FY'11 52

Chapter 7 Interpretation of questioner 53

7.1 Demographic Questions 53

7.2 Main Questions 58

Chapter 8 Conclusion 68

Chapter 9 Annexure 69

9.1 Questioner 69

Chapter 10 Bibliography 71


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List ofTable

Table

No.

Particulars Page

no.

1 Major Players of Online Trading in India 4

2 Top 10 currency traders 15

3 Most traded currencies 19

4 Top 20 largest countries by foreign exchange reserves 29

5 inter-governmental free-trade associations and supranational organizations 30

6 Share of top five investing countries in FDI inflows 38

7 Shareholders of MCX-SX 42

8 Contract Specifications for USDINR 43

9 Contract Specifications for EuroINR 44

10 Contract Specifications for Pound Sterling-INR 45

11 Contract Specifications for Japanese Yen-INR 46

12 GDP & GNP of India 50

13 Monetary Policy Rates: India 51

14 Lending & Deposit Rates : India 51

15 Data interpretation of gender 53

16 Data interpretation of age 54

17 Data interpretation ofeducation qualification 55

18 Data interpretation ofoccupation 56

19 Data interpretation ofannual income 57

20 Data interpretation ofcurrency preference 59

21 Data interpretation ofprimary object of investing 60

22 Data interpretation oftime duration 61

23 Data interpretation offactors to determine 62

24 Data interpretation ofpercentage criteria of investment 63

25 Data interpretation ofcurrency relay on 64

26 Data interpretation of risk in currency market 65

27 Data interpretation ofreturn in currency market 66

28 Data interpretation of service provided by broker 67


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List ofGraphs

No. Particulars Page no.

1 Pie chart of gender 53

2 Pie chart of age 54

3 Pie chart of education qualification 55

4 Pie chart of occupation 56

5 Pie chart of annual income 57

6 Pie chart of investment avenues 58

7 Pie chart of currency preference 59

8 Pie chart of primary object of investing 60

9 Pie chart of time duration 61

10 Pie chart of factors to determine 62

11 Pie chart of percentage criteria of investment 63

12 Pie chart of currency relay on 64

13 Pie chart of risk in currency market 65

14 Pie chart of return in currency market 66

15 Pie chart ofservice provided by broker 67


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Objective of the study

Primary Objective:

To Study Impact of Currency market in Indian economy.

Secondary Objective:

To study the on board aspects of corporate.

To Study the various services provided by Broker house to their clients.

To know investors experience in Forex market,

To study what other services investors expect from their broker house.

Limitations of the study

Theoretical data are taken from internet; possibilities of wrong data can take in the report.

Respondent could provide wrong data.

Shortage of time.

May small sample size doesnt cover the all population characteristics.


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Chapter 1. Introduction

The foreign exchange market or Currency market is a global, worldwide decentralized over-

the-counter financial market for trading 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. The

primary purpose of the foreign exchange is to assist international trade and investment, by

allowing businesses to convert one currency to another currency. For example, it permits a

US business to import British goods and pay Pound Sterling, even though the business's

income is in US 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. 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

worlds 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.

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Chapter 2. Company Profile

2.1. Introduction of the Company

Religare is a global financial services group with a presence across Asia, Africa, Middle

East, Europe and the Americas. Religare is promoted by the promoters of Ranbaxy

pharmaceuticals Limited. In India, Religares largest market, the group offers a wide array

of products and services ranging from insurance, asset management, broking and lending

solutions to investment banking and wealth management.

The group has also pioneered the concept of investments in alternative asset classes such as

arts and films. With over 10,000 employees across multiple geographies, Religare serves over

a million clients, including corporate and institutions, high net worth families and individuals,

and retail investors. Religare operate from six regional offices and 25 sub-regional offices

and have a presence in 330 cities and towns controlling 979 locations which are managed

either directly by Religare or by our Business Associates all over India, the company have a

representative office in London. While the majority of Religare offices provide the full

complement of its services yet it has dedicated offices for investment banking, institutional

brokerage, portfolio management services and priority client services.

The Company is empanelled with UTI, IDBI, IFCI, SBI, BOI-MF, Punjab National Bank,

PNB-MF, Oriental Insurance, GIC, UTI-Offshore, ICICI Can bank MF, Punjab & Sind Bank,

Pioneer ITI, SUN F&C, IDBI Principal, Prudential ICICI, ING Baring and J M Mutual Fund.

RELIGARE was founded with the vision of providing integrated financial care driven by the

relationship of trust.

The bouquet of services offered by RELIGARE includes Broking (Stocks, currency and

Commodities), Depository Participant Service, Advisory on Mutual Fund Investments and

Portfolio Management Services. RELIGARE is a pioneer in the concept of partnership to

reach multiple locations in order to effectively service its large base of individual clients.

Besides the reach of RELIGARE, the clients of the company greatly benefit by its strong

research capability, which encompasses fundamentals as well as technical knowledge.


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Name

Religare is a Latin word that translates as 'to bind together'. This name has been chosen to

reflect the integrated nature of the financial services the company offers.

SymbolThe Religare name is paired with the symbol of a four-leaf clover. Traditionally, it is

considered good fortune to find a four-leaf clover as there is only one four-leaf clover for

every 10,000 three-leaf clovers found. For us, each leaf of the clover has a special meaning. It

is a symbol of Hope, Trust, Care, and Good Fortune. For the world, it is the symbol of

Religare. For us, each leaf of the clover has a special meaning. It is a symbol of Hope,

Trust, Care, And Good Fortune. For the world, it is the symbol of Religare.

The first leaf of the clover represents Hope. The aspirations to succeed. The dream of

becoming. Of new possibilities. It is the beginning of every step and the foundation on which

a person reaches for the stars.

The second leaf of the clover represents Trust. The ability to place ones own faith in

another. To have a relationship as partners in a team. To accomplish a given goal with the

balance that brings satisfaction to all, not in the binding, but in the bond that is built.

The third leaf of the clover represents Care. The secret ingredient that is the cement inevery relationship. The truth of feeling that underlines sincerity and the triumph of diligence

in every aspect. From it springs true warmth of service and the ability to adapt to evolving

environments with consideration to all.

The fourth and final leaf of the clover represents Good Fortune. Signifying that rare

ability to meld opportunity and planning with circumstance to generate those often looked for

remunerative moments of success.

Hope, Trust, Care, Good Fortune. All elements perfectly combine in the emblematic

and rare, four-leaf clover to visually symbolize the values that bind together and form the

core of the Religare vision.

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2.2. Religare Securities Limited

Religare Securities Limited (RSL), a 100% subsidiary of Religare Enterprises Limited is a

leading equity and securities firm in India. The company currently handles sizeable volumestraded on NSE and in the realm of online trading and investments; it currently holds a

reasonable share of the market. The major activities and offerings of the company today are

Equity Broking, Depository Participant Services, Portfolio Management Services,

International Advisory Fund Management Services, Institutional Broking and Research

Services. To broaden the gamut of services offered to its investors, the company offers an

online investment portal armed with a host of revolutionary features.

RSL is a member of the National Stock Exchange of India, Bombay Stock Exchange of

India, Depository Participant with National Securities Depository Limited and Central

Depository Services (I) Limited, and is a SEBI approved Portfolio Manager.

Religare has been constantly innovating in terms of product and services and to offer such

incisive services to specific user segments it has also started the NRI, FII, HNI and Corporate

Servicing groups. These groups take all the portfolio investment decisions depending upon a

clients risk / return parameter.

Religare has a very credible Research and Analysis division, which not only caters to the

need of our Institutional clientele, but also gives their valuable inputs to investment dealers.

VISION AND MISSION

Vision To build Religare as a globally trusted brand in the financial services domain and

present it as the Investment Gateway of India'.

Mission Providing complete financial care driven by the core values of diligence and

transparency.

Brand Essence Core brand essence is Diligence and Religare is driven by ethical and

dynamic processes for wealth creation.

Major Players of Online Trading in India

(table 1)

Religare Securities Angel Trade

Share Khan ICICI Direct

India bulls Reliance Money

Motilal Oswal Standard Chartered

HDFC IDBI Paisa Builder

HSBC Geojit

Networth Kotak Securities


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2.3. Religare securities offering different services.

a). Equity & Derivative:

Religare is one of the heavyweight equity players in India with membership of National

Stock Exchange of India and Bombay Stock Exchange - both major exchanges of India. Webelieve in innovative services that could cater a range of customers according to their

requirements.

b). Commodities: Religare Commodities Limited is a member of both the exchanges (MCX

& NCDEX) that allows you to trade in all the commodities traded at both the exchanges. At

present, trading in commodities is restricted to futures contracts only. Religare is currently

offering special services to our esteemed investors in commodities:. Portfolio Advisory

Services (COMPASS) - This allows investors to get the benefit of our in-depth research

services and generate better returns with minimal risk.

c). Depository Services: Religare is among the few major Depository Participants holding

securities worth more than Rs.6000 crore under its management. RSL provides depository

services to investors as a Depository Participant with NSDL and CDSL.

d). Portfolio Management Services The main idea behind Portfolio Management Services is

to manage our client's wealth more efficiently, reduce risk by diversifying across assets,

sectors and funds, and maximizing returns.

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r

2.4. Group of companies

ReligareHealth

Insurance

ReligareSecurities

LtdReli

gafin

arelieest

limited

AegonReligare

Lifeinsurance RELIGARE

ENTERPRISE LTD

ReligareFinancelimited

Religareassets

Management

Company

ReligareCommodit

iesLimited

ReligareInsuranceBroaking

Limited

ReligareCapitalMarket

Limited


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2.5. General information

Name- Religare Securities Limited

Corporate office address - Religare Securities Limited,

D3, P3B, District Centre,

Saket, New Delhi-110017,

Phone: +91-11-39125000

Board of directors -

1. Mr. Sunil Godhwani

Chairman and Managing Director

2. Mr Shachindra Nath

Group CEO3. Mr. Anil Saxena

Chief Financial Officer

4. Mr. Harpal Singh

Non Executive Director

5. Mr. Deepak Ramchand Sabnani

Independent Director

6. Ms. Kathryn Matthews


7. Mr. Padam Bahl

Independent Director8. Mr. J. W. Balani


9. Ms. Sunita Naidoo


10. Mr. Stuart D Pearce


11. Mr. Ravi Mehrotra

Board Member

12. Mr. R. K. Shetty

Alternate to Mr. J. W. Balani13. Capt. G. P. S. Bhalla

Alternate to Mr. Deepak Sabnani

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Chapter 3. Research Methodology

3.1. Research Design

A research design is a framework or blueprint for conducting the marketing research project.

It specifies the details of the procedures necessary for obtaining the information needed to

structure and solve marketing research problems.

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RESEARCH DESIGE:-

1. Exploratory research2. Conclusive research

1. Exploratory Design:-

In exploratory design first collect the information about research.

Understand foreign exchange market

About foreign exchange market in India

About Indian economy

Impact of currency market in Indian economy

Collection of primary data from past research.

Then collection secondary data from Books, Magazines, Internet etc.

Then start qualitative research in this the interview of branch manager &

relationship manager of Religare securities limited.

2. Conclusive research design:

In conclusive research main part is survey.

In this research design we get perfect conclusion.

It is structure.

In conclusive research design two types

a. Causal research

b. Descriptive research

In this research use Descriptive research

descriptive research two types

i. Cross sectional

ii. Longitudinal design

In cross sectional

In cross sectional use Single cross sectional design because in our research the

information collects only ones a time.

In longitudinal design use panel.

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Research design :- 1. Exploratory research

2. Conclusive research

1. Exploratory research :- a. Secondary researchb. Qualitative research

I. Focus group interview

II. In-depth interview

2. Conclusive research

Descriptive research

Cross-sectional

>

>

>

Descriptive research.

I. cross sectional

signal cross-sectional

3.2. Define the target population

1. Target population: The collection of elements or objects that process the information

sought by the researcher and about which inferences are to be made.

2. Elements: An object that possesses the information sought by the researcher.

3. Sampling unit: The basic unit containing the elements of the population to be

sampled.

4. Sampling frame: A representation of the elements of the target population.

It consists of a list or set of direction for identifying the target population.

5. Extent: Extent refers to the geographical boundaries.

6. Time: Time is time period under consideration.

Target population: All the account holders of Religare Securities Limited, who trade in

currency.

Elements: investors of currency market.

Sampling unit: investors of currency market

Sampling frame: Not available.

Extent: Ahemadabad

Time: 11.00 A.M to 5.00 P.M

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3.3. The six W

1. Who: who are respondent?

The accounts holder in Religare Securities who are trading in Forex Market

2. What: what information should be obtained from the respondent?

A wide variety of information could be obtained, including:

a. What are income criteria?

b. In which financial instrument they invest in?

c. Factors they determine before investing.

3. When: when should the information is obtained from the respondent?

11.00a.m. to 5.00p.m.

4. Where: where should the respondent is contacted to obtain the required information?

The information was collected from the Religare Securities, Parimal Garden, Ahmedabad.

5. Why: why are we obtaining information from the respondent?

It is the necessary step to determine the factors of currency market impact in Indian economy

because of the research project assigned.

6. Way: In what way are we going to obtain information from the respondent?

a. Personal interview with questioners

b. Expert opinion

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Chapter 4. Foreign Exchange Markets in India

Historically the value of goods was expressed through some other goods, for example - a

barter economy where individuals exchange goods. The obvious disadvantages of such a

system encouraged establishment of more generally accepted and understand means of goodsexchange long time ago in history - to set a common scale of value. In different places

everything from teeth to jewelry has served this purpose but later metals, and especially gold

and silver, were introduced as an accepted means of payment, and also a reliable form of

value storage.

Originally, coins were basically minted from the metal, but stable political systems

introduced a paper form of IOUs (I owe you) which gained wide acceptance during the

middle Ages. Such paper IOUs became the basis of our modern currencies.

Before First World War most central banks supported currencies with gold. Even though

banknotes always could be exchanged for gold, in reality this did not happen that often,

developing an understanding that full reserves are not really needed.

Sometimes huge supply of banknotes without gold support led to giant inflation and hence

political instability. To protect national interests foreign exchange controls were introduced to

demand more responsibility from market players.

Closer to the end of World War II, the Bretton Woods agreement was signed as the initiative

of the USA in July 1944. The Bretton Woods Conference rejected John Maynard Keynessuggestion for a new world reserve currency in favor of a system built on the US dollar.

Other international institutions such as the IMF, the World Bank and GATT (General

Agreement on Tariffs and Trade) were created in the same period as the emerging victors of

WW2 searched for a way to avoid the destabilizing monetary crises which led to the war. The

Bretton Woods agreement resulted in a system of fixed exchange rates that partly reinstated

the gold standard, fixing the US dollar at USD35/oz and fixing the other main currencies to

the dollar - and was intended to be permanent.

The Bretton Woods system came under increasing pressure as national economies moved in

different directions during the sixties. A number of realignments kept the system alive for along time, but eventually Bretton Woods collapsed in the early seventies following president

Nixon's suspension of the gold convertibility in August 1971. The dollar was no longer

suitable as the sole international currency at a time when it was under severe pressure from

increasing US budget and trade deficits.

The following decades have seen foreign exchange trading develop into the largest global

market by far. Restrictions on capital flows have been removed in most countries, leaving the

market forces free to adjust foreign exchange rates according to their perceived values.

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But the idea of fixed exchange rates has by no means died. The EEC (European Economic

Community) introduced a new system of fixed exchange rates in 1979, the European

Monetary System. This attempt to fix exchange rates met with near extinction in 1992-93,

when pent-up economic pressures forced devaluations of a number of weak European

currencies. Nevertheless, the quest for currency stability has continued in Europe with the

renewed attempt to not only fix currencies but actually replace many of them with the Euro in

2001.

The lack of sustainability in fixed foreign exchange rates gained new relevance with the

events in South East Asia in the latter part of 1997, where currency after currency was

devalued against the US dollar, leaving other fixed exchange rates, in particular in South

America, looking very vulnerable.

But while commercial companies have had to face a much more volatile currency

environment in recent years, investors and financial institutions have found a newplayground. The size of foreign exchange markets now dwarfs any other investment market

by a large factor. It is estimated that more than USD 3,000 billion is traded every day, far

more than the world's stock and bond markets combined.

Forex (Foreign Exchange) is the international financial market used for trade of world

currencies. It has been working since 70s of the 20th century - from the moment when the

biggest world nations decided to switch from fixed exchange rates to floating ones. Daily

volume of Forex trade exceeds 4 trillion United States dollars, and this number is always

growing .Main currency for Forex operations is the United States dollar (USD).

Unlike stock exchanges, Forex market doesn't have any fixed schedule or operating hours -

it's open 24 hours per day, 5 days per week from Monday to Friday, since buy/sell orders are

performed by world banks any time during the day or night (some banks even work on

Saturdays and Sundays). Just like any other exchange, Forex market is driven by supply and

demand of a particular tool. For instance, there are buyers and sellers for "Euro vs US dollar".

Exchange rates at Forex are changing constantly, and fluctuations may happen many times

per second - this market is very liquid.


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4.1. Market Size and liquidity

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 inthe 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 was US$3.98 trillion in April 2010 (vs $1.7 trillion in 1998). Of this

$3.98 trillion, $1.5 trillion was spot foreign exchange transactions and $2.5 trillion was traded

in outright forwards, FX swaps and other currency derivatives.

Trading in the UK accounted for 36.7% of the total, making UK by far the most important

global center for foreign exchange trading. In second and third places, respectively, trading in

the USA 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 2010 (double the turnover recorded in April 2007).

Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. FX

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 FX derivative products (like currency futures

and options on currency futures) on their exchanges. All these developed countries already

have fully convertible capital accounts. A number of emerging countries do not permit FX

derivative products on their exchanges in view of controls on the capital accounts. The use of

foreign exchange derivatives is growing in many emerging economies. Countries such as

Korea, South Africa, and India have established currency futures exchanges, despite having

some controls on the capital account.

Foreign exchange trading increased by 20% between 2007 and 2010 and has more thandoubled since 2004. The increase in turnover is due to a number of factors: the growingimportance 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. Thegrowth of electronic execution methods and the diverse selection of execution venues havelowered transaction costs, increased market liquidity, and attracted greater participation frommany customer types. In particular, electronic trading via online portals has made it easier forretail traders to trade in the foreign exchange market. By 2010, retail trading is estimated toaccount for up to 10% of spot FX turnover, or $150 billion per day.

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Top 10 currency traders % of overall volume, May 2011

Rank Name Market share

1 Deutsche Bank 15.64%

2 Barclays Capital 10.75%

3 UBS AG 10.59%

4 Citi 8.88%

5 JPMorgan 6.43%

6 HSBC 6.26%

7 Royal Bank of Scotland 6.20%

8 Credit Suisse 4.80%

9 Goldman Sachs 4.13%

10 Morgan Stanley 3.64%

(Table 2)

Because foreign exchange is an OTC (over-the-counter) market where brokers/dealers

negotiate directly with one another, there is no central exchange or clearing house. The

biggest geographic trading center is the UK, primarily London, which according to The CityUK 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 IMF

calculates the value of its SDRs every day, they use the London market prices at noon that

day.


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4.2. Market participants

Unlike a stock market, the foreign exchange market is divided into levels of access. At the

top is the inter-bank market, which is made up of the largest commercial banks and securities

dealers. Within the inter-bank market, spreads, which are the difference between the bid andask prices, are razor sharp and not known to players outside the inner circle. The difference

between the bid and ask prices widens (for example from 0-1 pip to 1-2 pips for a currencies

such as the EUR) as you go down the levels of access. This is due to volume. If a trader can

guarantee large numbers of transactions for large amounts, they can demand a smaller

difference between the bid and ask price, which is referred to as a better spread. The levels of

access that make up the foreign exchange market are determined by the size of the "line" (the

amount of money with which they are trading). The top-tier interbank market accounts for

53% of all transactions. From there, smaller banks, followed by large multi-national

corporations (which need to hedge risk and pay employees in different countries), large hedge

funds, and even some of the retail FX market makers. According to Galati and Melvin,

Pension funds, insurance companies, mutual funds, and other institutional investors have

played an increasingly important role in financial markets in general, and in FX markets in

particular, since the early 2000s. (2004) In addition, he notes, Hedge funds have grown

markedly over the 20012004 period in terms of both number and overall size. Central

banks also participate in the foreign exchange market to align currencies to their economic

needs.

a. Banks

The interbank market caters for both the majority of commercial turnover and large amounts

of speculative trading every day. Many large banks may trade billions of dollars, daily. Some

of this trading is undertaken on behalf of customers, but much is conducted by proprietary

desks, which are trading desks for the bank's own account. Until recently, foreign exchange

brokers did large amounts of business, facilitating interbank trading and matching anonymous

counterparts for large fees. Today, however, much of this business has moved on to more

efficient electronic systems. The broker squawk box lets traders listen in on ongoing

interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than

just a few years ago.

b. Commercial companies

An important part of this market comes from the financial activities of companies seeking

foreign exchange to pay for goods or services. Commercial companies often trade fairly small

amounts compared to those of banks or speculators, and their trades often have little short

term impact on market rates. Nevertheless, trade flows are an important factor in the long-

term direction of a currency's exchange rate. Some multinational companies can have an

unpredictable impact when very large positions are covered due to exposures that are not

widely known by other market participants.

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c. Central banks

National central banks play an important role in the foreign exchange markets. They try to

control the money supply, inflation, and/or interest rates and often have official or unofficial

target rates for their currencies. They can use their often substantial foreign exchange

reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing

speculation" is doubtful because central banks do not go bankrupt if they make large losses,

like other traders would, and there is no convincing evidence that they do make a profit

trading.

d. Forex Fixing

Forex fixing is the daily monetary exchange rate fixed by the national bank of each country.

The idea is that central banks use the fixing time and exchange rate to evaluate behavior of

their currency. Fixing exchange rates reflects the real value of equilibrium in the forexmarket. Banks, dealers and online foreign exchange traders use fixing rates as a trend

indicator.

The mere expectation or rumor of central bank intervention might be enough to stabilize a

currency, but aggressive intervention might be used several times each year in countries with

a dirty float currency regime. Central banks do not always achieve their objectives. The

combined resources of the market can easily overwhelm any central bank. Several scenarios

of this nature were seen in the 199293 ERM collapse, and in more recent times in Southeast

Asia.

e. 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.

f. 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. Whilst the number of this type of


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specialist firms is quite small, many have a large value of Assets Under Management (AUM),

and hence can generate large trades.

g. Retail foreign exchange traders

Individual Retail speculative traders constitute a growing segment of this market with the

advent of retail forex platforms, both in size and importance. Currently, they participate

indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in

the USA by the CFTC and NFA have in the past been subjected to periodic foreign exchange

scams. To deal with the issue, the NFA and CFTC began (as of 2009) imposing stricter

requirements, particularly in relation to the amount of Net Capitalization required of its

members. As a result many of the smaller and perhaps questionable brokers are now gone or

have moved to countries outside the US. A number of the forex brokers operate from the UK

under FSA regulations where forex trading using margin is part of the wider over-the-counter

derivatives trading industry that includes CFDs and financial spread betting.

There are two main types of retail FX brokers offering the opportunity for speculative

currency trading: brokers and dealers or market makers. Brokers serve as an agent of the

customer in the broader FX market, by seeking the best price in the market for a retail order

and dealing on behalf of the retail customer. They charge a commission or mark-up in

addition to the price obtained in the market.Dealers ormarket makers, by contrast, typically

act as principal in the transaction versus the retail customer, and quote a price they are willing

to deal at.

h. Non-bank foreign exchange companies

Non-bank foreign exchange companies offer currency exchange and international payments

to private individuals and companies. These are also known as foreign exchange brokers but

are distinct in that they do not offer speculative trading but rather currency exchange with

payments (i.e., there is usually a physical delivery of currency to a bank account).

It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign

Exchange Companies. These companies' selling point is usually that they will offer better

exchange rates or cheaper payments than the customer's bank. These companies differ fromMoney Transfer/Remittance Companies in that they generally offer higher-value services.

i. Money transfer/remittance companies and bureau de changes

Money transfer companies/remittance companies perform high-volume low-value transfers

generally by economic migrants back to their home country. In 2007, the Aite Group

estimated that there were $369 billion of remittances (an increase of 8% on the previous

year). The four largest markets (India, China, Mexico and the Philippines) receive $95

billion. The largest and best known provider is Western Union with 345,000 agents globally

followed by UAE Exchange

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Bureau de change or currency transfer companies provide low value foreign exchange

services for travelers. These are typically located at airports and stations or at tourist locations

and allow physical notes to be exchanged from one currency to another. They access the

foreign exchange markets via banks or non bank foreign exchange companies.

Mosttradedcurrencies(May2011)

(Table 3)

Rank Currency ISO 4217 code (Symbol) % daily share

1United States

dollarUSD ($) 84.9%

2 Euro EUR () 39.1%

3 Japanese yen JPY () 19.0%

4 Pound sterling GBP () 12.9%

5 Australian dollar AUD ($) 7.6%

6 Swiss franc CHF (Fr) 6.4%

7 Canadian dollar CAD ($) 5.3%

8 Hong Kong dollar HKD ($) 2.4%

9 Swedish krona SEK (kr) 2.2%

10New Zealand

dollarNZD ($) 1.6%

11 South Korean won KRW 1.5%

12 Singapore dollar SGD ($) 1.4%

13 Norwegian krone NOK (kr) 1.3%

14 Mexican peso MXN ($) 1.3%

15 Indian rupee INR 0.9%

16 Other Currencies - 12.2%

Total 200%


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4.3. Trading characteristics

There is no unified or centrally cleared market for the majority of FX trades, and there is very

little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets,

there are rather a number of interconnected marketplaces, where different currenciesinstruments are traded. This implies that there is not a single exchange rate but rather a

number of different rates (prices), depending on what bank or market maker is trading, and

where it is. In practice the rates are often very close, otherwise they could be exploited by

arbitrageurs instantaneously. Due to London's dominance in the market, a particular

currency's quoted price is usually the London market price. A joint venture of the Chicago

Mercantile Exchange and Reuters, called Fx market space opened in 2007 and aspired but

failed to the role of a central market clearing mechanism.

The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all

important centers as well. Banks throughout the world participate. Currency trading happenscontinuously throughout the day; as the Asian trading session ends, the European session

begins, followed by the North American session and then back to the Asian session,

excluding weekends.

Fluctuations in exchange rates are usually caused by actual monetary flows as well as by

expectations of changes in monetary flows caused by changes in gross domestic product

(GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity,

Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses,

large cross-border M&A deals and other macroeconomic conditions. Major news is releasedpublicly, often on scheduled dates; so many people have access to the same news at the same

time. However, the large banks have an important advantage; they can see their customers'

order flow.

Currencies are traded against one another. Each currency pair thus constitutes an individual

trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY

are the ISO 4217 international three-letter code of the currencies involved. The first currency

(XXX) is the base currency that is quoted relative to the second currency (YYY), called the

counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD)

1.5465 is the price of the euro expressed in US dollars, meaning 1 euro = 1.5465 dollars. The

market convention is to quote most exchange rates against the USD with the US dollar as the

base currency (e.g. USDJPY, USDCAD, USDCHF). The exceptions are the British pound

(GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where

the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).

The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive

currency correlation between XXXYYY and XXXZZZ.

On the spot market, according to the 2010 Triennial Survey, the most heavily traded bilateralcurrency pairs were:

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EURUSD : 28%

USDJPY : 14%

GBPUSD : 9%

and the US currency was involved in 84.9% of transactions, followed by the euro (39.1%),

the yen (19.0%), and sterling (12.9%). Volume percentages for all individual currencies

should add up to 200%, as each transaction involves two currencies.

Trading in the euro has grown considerably since the currency's creation in January 1999, and

how long the foreign exchange market will remain dollar-centered is open to debate. Until

recently, trading the euro versus a non-European currency ZZZ would have usually involved

two trades: EURUSD and USDZZZ. The exception to this is EURJPY, which is an

established traded currency pair in the interbank spot market. As the dollar's value has eroded

during 2008, interest in using the euro as reference currency for prices in commodities (such

as oil), as well as a larger component of foreign reserves by banks, has increaseddramatically. Transactions in the currencies of commodity-producing countries, such as

AUD, NZD, CAD, have also increased.

4.4. Determinants of FX rates

The following theories explain the fluctuations in FX rates in a floating exchange rate regime

(In a fixed exchange rate regime, FX rates are decided by its government):

I. 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.

II. Balance of payments model: 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.

III. Asset market model: views currencies as an important asset class for constructing

investment portfolios. Assets prices are influenced mostly by peoples willingness tohold 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 FX rates levels 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


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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.

a. Economic factors

These include: (a) economic policy, disseminated by government agencies and central

banks, (b) economic conditions, generally revealed through economic reports, and

other economic indicators.

Economic policy comprises government fiscal policy (budget/spending practices) and

monetary policy (the means by which a government's central bank influences the

supply and "cost" of money, which is reflected by the level of interest rates).

Government budget deficits or surpluses: The market usually reacts negatively to

widening government budget deficits, and positively to narrowing budget deficits.

The impact is reflected in the value of a country's currency.

Balance of trade levels and trends: The trade flow between countries illustrates the

demand for goods and services, which in turn indicates demand for a country's

currency to conduct trade. Surpluses and deficits in trade of goods and services reflect

the competitiveness of a nation's economy. For example, trade deficits may have a

negative impact on a nation's currency.

Inflation levels and trends: Typically a currency will lose value if there is a high level

of inflation in the country or if inflation levels are perceived to be rising. This is

because inflation erodes purchasing power, thus demand, for that particular currency.

However, a currency may sometimes strengthen when inflation rises because of

expectations that the central bank will raise short-term interest rates to combat rising

inflation.

Economic growth and health: Reports such as GDP, employment levels, retail sales,capacity utilization and others, detail the levels of a country's economic growth and

health. Generally, the more healthy and robust a country's economy, the better its

currency will perform, and the more demand for it there will be.

Productivity of an economy: Increasing productivity in an economy should positively

influence the value of its currency. Its effects are more prominent if the increase is in

the traded sector.

b. Political conditions

Internal, regional, and international political conditions and events can have aprofound effect on currency markets.

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All exchange rates are susceptible to political instability and anticipations about the

new ruling party. Political upheaval and instability can have a negative impact on a

nation's economy. For example, destabilization of coalition governments in Pakistan

and Thailand can negatively affect the value of their currencies. Similarly, in a

country experiencing financial difficulties, the rise of a political faction that is

perceived to be fiscally responsible can have the opposite effect. Also, events in one

country in a region may spur positive/negative interest in a neighboring country and,

in the process, affect its currency.

c. 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," atype 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-termmarket 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.

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4.5. Financial instruments

A. 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.

B. Forward

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 transactionoccurs 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.

C. Swap

The most common type of forward transaction is the FX swap. In an FX 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.

D. Future

Futures are standardized 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.

E. 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 FX options

market is the deepest, largest and most liquid market for options of any kind in the world.

4.6. Speculation

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 thosepeople who don't wish to bear it, to those who do. Other economists such as Joseph Stiglitz

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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 them for having caused the

unsustainable economic conditions.

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4.7. Foreign exchange reserves

Introduction

Foreign exchange reserves (also called Forex reserves orFX reserves) in a strict sense

are only the foreign currency deposits and bonds held by central banks and monetary

authorities. However, the term in popular usage commonly includes foreign exchange

and gold, SDRs and IMF reserve positions. This broader figure is more readily available, but

it is more accurately termed official international reserves orinternational reserves. These

are assets of the central bank held in different reserve currencies, mostly the US dollar, and to

a lesser extent the euro, the UK pound, and the Japanese yen, and used to back its liabilities,

e.g. the local currency issued, and the various bank reserves deposited with the central bank,

by the government or financial institutions.

History

Official international reserves, the means of official international payments, formerly

consisted only of gold, and occasionally silver. But under the Bretton Woods system, the

US dollar functioned as a reserve currency, so it too became part of a nation's official

international reserve assets. From 1944-1968, the US dollar was convertible into gold through

the Federal Reserve System, but after 1968 only central banks could convert dollars into gold

from official gold reserves, and after 1973 no individual or institution could convert US

dollars into gold from official gold reserves. Since 1973, no major currencies have been

convertible into gold from official gold reserves. Individuals and institutions must now buy

gold in private markets, just like other commodities. Even though US dollars and other

currencies are no longer convertible into gold from official gold reserves, they still can

function as official international reserves.

Purpose

In a flexible exchange rate system, official international reserve assets allow a central bank to

purchase the domestic currency, which is considered a liability for the central bank (since it

prints the money or fiat currency as IOUs). This action can stabilize the value of the domestic

currency.

Central banks throughout the world have sometimes cooperated in buying and selling official

international reserves to attempt to influence exchange rates.

Changes in reserves

The quantity of foreign exchange reserves can change as a central bank implements monetary

policy. A central bank that implements a fixed exchange rate policy may face a situation

where supply and demand would tend to push the value of the currency lower or higher (an

increase in demand for the currency would tend to push its value higher, and a decrease

lower). In a flexible exchange rate regime, these operations occur automatically, with the

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27

central bank clearing any excess demand or supply by purchasing or selling the foreign

currency. Mixed exchange rate regimes ('dirty floats', target bands or similar variations) may

require the use of foreign exchange operations (sterilized or unsterilized) to maintain the

targeted exchange rate within the prescribed limits .

Foreign exchange operations that are unsterilized will cause an expansion or contraction in

the amount of domestic currency in circulation, and hence directly affect monetary policy and

inflation: An exchange rate target cannot be independent of an inflation target. Countries that

do not target a specific exchange rate are said to have a floating exchange rate, and allow the

market to set the exchange rate; for countries with floating exchange rates, other instruments

of monetary policy are generally preferred and they may limit the type and amount of foreign

exchange interventions. Even those central banks that strictly limit foreign exchange

interventions, however, often recognize that currency markets can be volatile and may

intervene to counter disruptive short-term movements.

To maintain the same exchange rate if there is increased demand, the central bank can issue

more of the domestic currency and purchase the foreign currency, which will increase the

sum of foreign reserves. In this case, the currency's value is being held down; since (if there

is no sterilization) the domestic money supply is increasing (money is being 'printed'), this

may provoke domestic inflation (the value of the domestic currency falls relative to the value

of goods and services).

Since the amount of foreign reserves available to defend a weak currency (a currency in lowdemand) is limited, a foreign exchange crisis or devaluation could be the end result. For a

currency in very high and rising demand, foreign exchange reserves can theoretically be

continuously accumulated, although eventually the increased domestic money supply will

result in inflation and reduce the demand for the domestic currency (as its value relative to

goods and services falls). In practice, some central banks, through open market operations

aimed at preventing their currency from appreciating, can at the same time build substantial

reserves.

In practice, few central banks or currency regimes operate on such a simplistic level, andnumerous other factors (domestic demand, production and productivity, imports and exports,

relative prices of goods and services, etc) will affect the eventual outcome. As certain impacts

(such as inflation) can take many months or even years to become evident, changes in foreign

reserves and currency values in the short term may be quite large as different markets react to

imperfect data.

Costs, benefits, and criticisms

Large reserves of foreign currency allow a government to manipulate exchange rates -

usually to stabilize the foreign exchange rates to provide a more favorable economic


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environment. In theory the manipulation of foreign currency exchange rates can provide the

stability that a gold standard provides, but in practice this has not been the case. Also, the

greater a country's foreign reserves, the better position it is in to defend itself

from speculative attacks on the domestic currency.

There are costs in maintaining large currency reserves. Fluctuations in exchange markets

result in gains and losses in the purchasing power of reserves. Even in the absence of a

currency crisis, fluctuations can result in huge losses. For example, China holds huge U.S.

dollar-denominated assets, but if the U.S. dollar weakens on the exchange markets, the

decline results in a relative loss of wealth for China. In addition to fluctuations in exchange

rates, the purchasing power of fiat money decreases constantly due to devaluation

through inflation. Therefore, a central bank must continually increase the amount of its

reserves to maintain the same power to manipulate exchange rates. Reserves of foreign

currency provide a small return in interest. However, this may be less than the reduction in

purchasing power of that currency over the same period of time due to inflation, effectively

resulting in a negative return known as the "quasi-fiscal cost". In addition, large currency

reserves could have been invested in higher yielding assets.

Excess reserves

Foreign exchange reserves are important indicators of ability to repay foreign debt and for

currency defense, and are used to determine credit ratings of nations, however, other

government funds that are counted as liquid assets that can be applied to liabilities in times ofcrisis include stabilization funds, otherwise known as sovereign wealth funds. If those were

included, Norway, Singapore and Persian Gulf States would rank higher on these lists,

and UAE's $1.3 trillion Abu Dhabi Investment Authority would be second after China. Apart

from high foreign exchange reserves, Singapore also has significant government and

sovereign wealth funds including Temasek Holdings, valued in excess of $145 billion

and GIC, valued in excess of $330 billion. India is also planning to create its own investment

firm from its foreign exchange reserves.

On May 2011, an estimated that Asia has $3.5 trillion of foreign reserves or is around two-thirds of the world's reserves and a stark contrast to the indebtedness in many developed

Western economies.


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29

The following is a list of

(table 4)

the top 20 largest countries by foreign exchange reserves:

Rank Country Billion USD (end ofmonth)

1 People's Republic of China $ 3045 (Mar 2011)

2 Japan $ 1140 (May 2011)

3 Russia $ 525 (Apr 2011)

4 Saudi Arabia $ 466 (Mar 2011)

5 Republic of China (Taiwan) $ 400 (Apr 2011)

6 Brazil $ 333 (May 2011)

7 India $ 310 (Ma y 2011)

8 South Korea $ 307 (Apr 2011)

9 Switzerland $ 280 (Mar 2011)

10 Hong Kong $ 277 (Apr 2011)

11 Singapore $ 243 (Apr 2011)

12 Germany $ 221 (Mar 2011)

13 Thailand $ 190 (Apr 2011)

14 France $ 173 (Mar 2011)

15 Italy $ 164 (Mar 2011)

16 Algeria $ 155 (Dec 2010)

17 United States $ 143 (Apr 2011)

18 Mexico $ 128 (Mar 2011)

19 United Kingdom $ 119 (Apr 2011)

20 Malaysia $ 114 (Mar 2011)


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30

The following is a list of

organizations.

(Table 5)

inter-governmental free-trade associations and supranational

Rank Country Billion USD (end ofmonth)

1 European Economic Area $ 1 416 (Feb 2011)

2 European Union $ 1 356 (Feb 2011)

3 Eurozone $ 798 (Feb 2011)

These few holders account for more than 60% of total world foreign currency reserves. The

adequacy of the foreign exchange reserves is more often expressed not as an absolute level,

but as a percentage of short-term foreign debt, money supply, or average monthly imports.


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3

Chapter 5. Economy of India

Social democratic policies governed India's economy from 1947 to 1991. The economy was

characterized by extensive regulation, protectionism, public, pervasive corruption and slow

growth. Since 1991, continuing economic liberalization has moved the country towards

market. A revival of economic reforms and better economic policy in first decade of the 21st

century accelerated India's economic growth rate. In recent years, Indian cities have

continued to liberalize business regulations. By 2008, India had established itself as the

world's second-fastest growing major economy.

However, as a result of the financial crisis of 20072010, coupled with a poor monsoon,

India's gross domestic product (GDP) growth rate significantly slowed to 6.7% in 200809,

but subsequently recovered to 7.4% in 200910, while the fiscal deficit rose from 5.9% to a

high 6.5% during the same period. Indias current account deficit surged to 4.1% of GDP

during Q2 FY11 against 3.2% the previous quarter. The unemployment rate for 20092010,according to the state Labor Bureau, was 9.4% nationwide, rising to 10.1% in rural areas,

where two-thirds of the 1.2 billion populations live.

India's large service industry accounts for 57.2% of the country's GDP while the industrial

and agricultural sectors contribute 28.6% and 14.6% respectively. Agriculture is the

predominant occupation in India, accounting for about 52% of employment.

The service sector makes up a further 34%, and industrial sector around 14%. However,

statistics from a 2009-10 government survey, which used a smaller sample size than earlier

surveys, suggested that the share of agriculture in employment had dropped to 45.5%.

Major industries include telecommunications, textiles, chemicals, food processing, steel,

transportation equipment, cement, mining, petroleum, machinery, information technology-

enabled services and pharmaceuticals. The labor totals 500 million workers. Major

agricultural products include rice, wheat, oilseed, cotton, jute, tea, sugarcane, potatoes,

cattle, water buffalo, sheep, goats, poultry and fish. In 2009-2010, India's top five trading

partners are United Arab Emirates, China, United States, Saudi Arabia and Germany.

Previously a closed economy, India's trade and business sector has grown fast. India currently

accounts for 1.5% of world trade as of 2007 according to the World Trade Statistics of the

WTO in 2006, which valued India's total merchandise trade (counting exports and imports) at

$294 billion and India's services trade at $143 billion. Thus, India's global economic

engagement in 2006 covering both merchandise and services trade was of the order of $437

billion, up by a record 72% from a level of $253 billion in 2004. India's total trade in goods

and services has reached a share of 43% of GDP in 200506, up from 16% in 199091.

India's total merchandise trade (counting exports and imports) stands at $ 606.7 billion and is

currently the 11th largest in the world.


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5.1. Post-liberalization period (since 1991)

In the late 1970s, the government led by Morarji Desai eased restrictions on capacity

expansion for incumbent companies, removed price controls, reduced corporate taxes and

promoted the creation of small scale industries in large numbers. He also raised the income

tax levels at one point to a maximum of 97.5%, a record in the world for non-communist

economies. However, the subsequent government policy of Fabian socialism hampered the

benefits of the economy, leading to high fiscal deficits and a worsening current account. The

collapse of the Soviet Union, which was India's major trading partner, and the Gulf War,

which caused a spike in oil prices, resulted in a major balance-of-payments crisis for India,

which found itself facing the prospect of defaulting on its loans. India asked for a $1.8 billion

bailout loan from the International Monetary Fund (IMF), which in return demanded reforms.

In response, Prime Minister Narasimha Rao, along with his finance minister Manmohan

Singh, initiated the economic liberalization of 1991. The reforms did away with the Licence

Raj, reduced tariffs and interest rates and ended many public monopolies, allowing automatic

approval of foreign direct investment in many sectors. Since then, the overall thrust of

liberalization has remained the same, although no government has tried to take on powerful

lobbies such as trade unions and farmers, on contentious issues such as reforming labour laws

and reducing agricultural subsidies. By the turn of the 20th century, India had progressed

towards a free-market economy, with a substantial reduction in state control of the economy

and increased financial liberalization. This has been accompanied by increases in life

expectancy, literacy rates and food security, although the beneficiaries have largely been

urban residents.

While the credit rating of India was hit by its nuclear weapons tests in 1998, it has since been

raised to investment level in 2003 by S&P and Moody's. In 2003, Goldman Sachs predicted

that India's GDP in current prices would overtake France and Italy by 2020, Germany, UK

and Russia by 2025 and Japan by 2035, making it the third largest economy of the world,

behind the US and China. India is often seen by most economists as a rising economic

superpower and is believed to play a major role in the global economy in the 21st century.


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5.2. Sectors

Industry and services

Industry accounts for 28% of the GDP and employ 14% of the total workforce. In absolute

terms, India is 12th in the world in terms of nominal factory output. The Indian industrialsector underwent significant changes as a result of the economic reforms of 1991, which

removed import restrictions, brought in foreign competition, led to privatization of certain

public sector industries, liberalized the FDI regime, improved infrastructure and led to an

expansion in the production of fast moving consumer goods. Post-liberalization, the Indian

private sector was faced with increasing domestic as well as foreign competition, including

the threat of cheaper Chinese imports. It has since handled the change by squeezing costs,

revamping management, and relying on cheap labor and new technology. However, this has

also reduced employment generation even by smaller manufacturers who earlier relied on

relatively labor-intensive processes.

Textile manufacturing is the second largest source of employment after agriculture and

accounts for 20% of manufacturing output, providing employment to over 20 million

people. Ludhiana produces 90% of woollens in India and is known as the Manchester of

India. Tirupur has gained universal recognition as the leading source of hosiery, knitted

garments, casual wear and sportswear.

India is 13th in services output. The services sector provides employment to 23% of the work

force and is growing quickly, with a growth rate of 7.5% in 19912000, up from 4.5% in

195180. It has the largest share in the GDP, accounting for 55% in 2007, up from 15% in

1950. Information technology and business process outsourcing are among the fastestgrowing sectors, having a cumulative growth rate of revenue 33.6% between 199798 and

200203 and contributing to 25% of the country's total exports in 200708. The growth in the

IT sector is attributed to increased specialization, and an availability of a large pool of low

cost, highly skilled, educated and fluent English-speaking workers, on the supply side,

matched on the demand side by increased demand from foreign consumers interested in

India's service exports, or those looking to outsource their operations. The share of the Indian

IT industry in the country's GDP increased from 4.8 % in 200506 to 7% in 2008. In 2009,

seven Indian firms were listed among the top 15 technology outsourcing companies in the

world.

Mining forms an important segment of the Indian economy, with the country producing 79

different minerals (excluding fuel and atomic resources) in 200910, including iron

ore, manganese, mica,bauxite, chromite, limestone, asbestos, fluorite, gypsum, ochre, phosph

oric and silica sand Organized retail supermarkets accounts for 24% of the market as of

2008. Regulations prevent most foreign investment in retailing. Moreover, over thirty

regulations such as "signboard licenses" and "anti-hoarding measures" may have to be

complied before a store can open doors. There are taxes for moving goods from state to state,

and even within states. Tourism in India is relatively undeveloped, but growing at double

digits. Some hospitals woo medical tourism.

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Agriculture

Farmers work outside a rice field in Andhra Pradesh. India

is the second largest producer of rice in the world after

China, and Andhra Pradesh is the second largest rice

producing state in India with West Bengal being the largest.

India ranks second worldwide in farm output. Agriculture

and allied sectors like forestry, logging and fishing

accounted for 15.7% of the GDP in 200910, employed

52.1% of the total workforce, and despite a steady decline of its share in the GDP, is still the

largest economic sector and a significant piece of the overall socio-economic development of

India. Yields per unit area of all crops have grown since 1950, due to the special emphasis

placed on agriculture in the five-year plans and steady improvements in irrigation,

technology, application of modern agricultural practices and provision of agricultural credit

and subsidies since the Green Revolution in India. However, international comparisons reveal

the average yield in India is generally 30% to 50% of the highest average yield in the world.

India receives an average annual rainfall of 1,208 millimeters (47.6 in) and a total

annual precipitation of 4000 billion cubic meters, with the total utilizable water resources,

including surface and groundwater, amounting to 1123 billion cubic meters. 546,820 square

kilometers (211,130 sq mi) of the land area, or about 39% of the total cultivated area, is

irrigated. India's inland water resources including rivers, canals, ponds and lakes and marine

resources comprising the east and west coasts of the Indian ocean and other gulfs and bays

provide employment to nearly six million people in the fisheries sector. In 2008, India had

the world's third largest fishing industry.

India is the largest producer in the world of milk, jute and pulses, and also has the world's

second largest cattle population with 175 million animals in 2008. It is the second largest

producer of rice, wheat, sugarcane, cotton and groundnuts, as well as the second largest fruit

and vegetable producer, accounting for 10.9% and 8.6% of the world fruit and vegetable

production respectively. India is also the second largest producer and the largest consumer of

silk in the world, producing 77,000 million tons in 2005.

Banking and finance

The Indian money market is classified into the organized sector, comprising private, public

and foreign owned commercial banks and cooperative banks, together known as scheduled

banks, and the unorganized sector, which includes individual or family owned indigenous

bankers or money lenders and non-banking financial companies. The unorganized sector

and microcredit are still preferred over traditional banks in rural and sub-urban areas,

especially for non-productive purposes, like ceremonies and short duration loans.

Prime Minister Indira Gandhi nationalized 14 banks in 1969, followed by six others in 1980,

and made it mandatory for banks to provide 40% of their net credit to priority sectors likeagriculture, small-scale industry, retail trade, small businesses, etc. to ensure that the banks

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fulfill their social and developmental goals. Since then, the number of bank branches has

increased from 8,260 in 1969 to 72,170 in 2007 and the population covered by a branch

decreased from 63,800 to 15,000 during the same period. The total bank deposits increased

from 5,910 crore (US$1.32 billion) in 197071 to 3,830,922 crore (US$854.3 billion) in

200809. Despite an increase of rural branches, from 1,860 or 22% of the total number of

branches in 1969 to 30,590 or 42% in 2007, only 32,270 out of 500,000 villages are covered

by a scheduled bank.

India's gross domestic saving in 200607 as a percentage of GDP stood at a high

32.7%. More than half of personal savings are invested in physical assets such as land,

houses, cattle, and gold. The public sector banks hold over 75% of total assets of the banking

industry, with the private and foreign banks holding 18.2% and 6.5% respectively. Since

liberalization, the government has approved significant banking reforms. While some of these

relate to nationalized banks, like encouraging mergers, reducing government interfere

59335036 summer project report on currency market

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