MODULE 2

Vishnu lalLead college of management

Contents

• Exchange Control• India’s Forex Scenario

– BOP Crisis 1990’s– LERMS– Convertibility

• International Monetory Developments– Gold Standards– Bretton Woods

• Euro Markets• Guarantees in Trade

– Performance– Bid Bonds

PROBLEMS OF FOREIGN EXCHANGES

1.Existence of Different Currencies With Different Values

In today’s world economy, each country is having its own monetary system and monetary units and all the currencies of the world have different values

2. Disequilibrium in Demand and Supply of CurrenciesAll the currencies of the world are not equally

demanded. Some currencies have more demand in comparison to the supply and vice versa. Currencies having more demand in international market are called Hard or Dear currency

Currencies having more supply in comparison to their demand are called Soft Currencies

3 Lack of Stability in Exchange ratesThe foreign exchange rates also fluctuates frequently

due to several reasons. Due to lack of stability in their rates also there are many problems.

4. Problem of the methods of International

PaymentsThere is no generally accepted means and there are

several problems in accepting payments in soft currency. Due to these problems, the international payments become more complicated.

5 Problem of Transfer of PaymentsThere are several problems in transferring

payments because of so many hurdles and barriers imposed in the countries under exchange control

EXCHANGE CONTROL IN INDIA• Regulation at government level of money-flows

in and out of a country. • Exchange controls are usually maintained in the

belief that they help to protect a country's currency and its foreign-exchange reserves.

• The controls may restrict investments by residents overseas and non-residents' investments and participation in the local market.

• Big international currency movements tend not to obey such controls.

• Common exchange controls include banning the use of foreign currency and restricting the amount of domestic currency that can be exchanged within the country.

• Countries that employ exchange controls are those with weaker economies

• These controls allow countries a greater degree of economic stability by limiting the amount of exchange rate volatility due to currency inflows/outflows

Objectives of exchange control in India1. Protection of Balance of Payments. • When the balance of payments deficit of a nation

becomes large an chronic an its automatic correction is not possible, certain active measures have to be adopted.

• In normal times the adverse balance of payments caused value of country's currency to fall and helps in restoring equilibrium.

• But there are conditions under which a fall in the exchange value and currency has no effect on imports and exports.

• Under such situations, measures are adopted to stabilize the exchange value of currency at level higher than would b possible under free conditions.

2. Reducing Burden of Foreign Debt. • The exchange value of a currency is sometimes

fixed and maintained at higher level to lighten the burden of foreign debts contracted in terms of foreign currencies.

• By overvaluing currency, the foreign exchange earnings of the country from exports are increased in cases where the demand is inelastic and the prices in terms of the home currency to be paid for essential imports get reduced.

3. Raising the Level of Prices. • Sometimes the currency is undervalued to help

in raising certain conditions in thought desirable to stabilize the exchange rate at what can be called the equilibrium level, i.e., the level determined by market forces.

• Short-term fluctuations are eliminated by deliberate action of authorities.

4. Elimination of Short-term Fluctuations in Exchange Rate.

• Exchange regulation in certain conditions is thought desirable to stabilize the exchange rate at what can be called the equilibrium level, i.e., the level determined by market forces.

• Short-term fluctuations are eliminated by deliberate action of authorities.

5. Economic Planning. • Exchange control is an important part of

economic policy in any planned economy.• Planning involves a very careful use of foreign

exchange resources of the country so that only those goods are imported which are essential for the implementation of the plans.

• Exchange controls are resorted to regular the exports and imports in the light of plans

6. Encouragement of Certain Economic Activities. • One of the objectives of exchange regulations is

to encourage certain economic activities in the country.

• Certain industries can be developed by reducing the imports of commodities produced by them and restricting the availability of foreign exchange to pay for them.

• For example tourist traffic in the country is encouraged by making available to the tourists home currency at favorable rates

What is Eurocurrency?

• Eurocurrency is the term used to describe deposits residing in banks that are located outside the borders of the country that issues the currency the deposit is denominated in– For example: a deposit denominated in US dollars

residing in a Japanese bank is a Eurocurrency deposit, or more specifically a Eurodollar deposit.

Euro Currency Market

Description and Size of the Eurocurrency Markets• EurocurrencyIt refers to commercial bank deposits outside the country of

their issue.e.g. a deposit denominated in U.S. dollars in a British

commercial Bank (or even in a British branch of a U.S. bank) is called a Eurodollar.• Eurocurrency MarketThe market where Eurocurrencies are borrowed and lent.

How it Originated?• After the Second World War, the amount of U.S.

dollars outside the United States increased enormously.

• As a result, enormous sums of U.S. dollars were in custody of foreign banks outside the United States.

• During the Cold War period, especially after the invasion of Hungary in 1956, the Soviet Union feared that its deposits in North American banks would be frozen as a retaliation.

• It decided to move some of its holdings to the Moscow Narodny Bank, a Soviet-owned bank with a British charter.

• The British bank would then deposit that money in the US banks. There would be no chance of confiscating that money, because it belonged to the British bank and not directly to the Soviets. On February 28 1957, the sum of $800,000 was transferred, creating the first eurodollars.

• Gradually, as a result of the successive commercial deficits of the United States, the eurodollar market expanded worldwide.

• Thus, the currencies involved in the Eurodollar market are in no way different from currencies deposited with banks in the home country. It is only that Eurodollar is not under the orbit or surveillance of the monetary policy, where the currency in their home country is under the regulation of the national monetary policy

Features of Eurocurrency Market• It is an international market and it is under no

national control– It has come up as the most important channel for

mobilizing and deploying funds on an international scale. • It is a short term money market• Eurodollar markets are the time-deposit market.

The deposits here have a maturity period ranging one day to several months. Eurodollar is the short-term deposit. It is a wholesale market– It is so because Eurodollar is the currency that is dealt in

only large units. – Size of individual transaction is usually above $1million.

• It is highly competitive and sensible market:

– High competitive : This market is characterized as highly competitive because the market is growing and accepted internationally.

– Sensible Market: The Eurodollar market is said to be sensible because it responds faster to the changes in demand and supply of the funds and also reacts to changes in the interest rates.

Participants in Eurocurrency Market

• Government • International Organizations • Central Banks • Commercial Banks • Corporations • MNC • Traders • Individuals

• Participants have contributed in the demand and supply of the fund, in the following way:– Supply : • Central Banks of various countries are the suppliers; • they channel the fund through BIS. • Increase in the Oil Revenue of the OPEC has added to the

fund. MNCs and the traders place their surplus funds for the short-term gains.

– Demand : • Government demand for these funds to meet the deficit

arising due to meet the deficit arising due to the deficit in Balance of Payment and the rise in the oil prices.• Commercial Banks needs extra fund for lending. Some also

borrow for the better ‘window dressing’ in the year-end

Reasons for the Development and Growth of the Eurocurrency Market

• Higher interest rates often prevailing abroad on short-term deposits

• International corporations often found it very convenient to hold balances abroad for short periods in the currency in which they needed to make payments

• International corporations can overcome domestic credit restrictions by borrowing in the Eurocurrency market

Operation and Effects of Eurocurrency MarketsOperation

Eurobanks do not, in general, create money, but they are essentially financial intermediaries bringing together lenders and borrowers.

Effects

The Eurocurrency market can create great instability in exchange and other financial markets.

The Eurocurrency market reduces the effectiveness of domestic stabilization efforts of national governments

Eurocurrency markets are largely uncontrolled. As a result, a deep worldwide recession could render some of the system’s banks insolvent and possibly lead internationally to the type of bank panics that afflicted capitalist nations during the nineteenth century and the first third of the twentieth century.