The foreign exchange foreign market is the international or overseas market wherein foreign currencies are purchased and sold. It is an arrangement for purchasing and selling foreign currencies in which exporters sell the foreign currencies and importers purchased them.
The major parts of the foreign exchange market are exports and importers, travelers land investors, traders, speculators and brokers, commercial banks, and central banks of various nations countries of the world.
The US Dollar was traded for 47.05 Indian rupees on 02nd June 2006. The rupee-dollar conversion standard was Rs.47.05 for one US Dollar or One Indian rupee would get 0.02 US Dollars. On 31st May 2019, the INR-USD exchange rate was Rs. 69.68 for one USD or one INR would get 0.014 USD.
In the foreign exchange market, there are two different rates for purchasing and selling foreign currencies. These differences arise because of transaction costs in dealing with foreign currencies.
Under the fixed exchange rate system, the foreign exchange rate is fixed by the public authority(government). The fixed exchange rate was set up in the year 1944 under an agreement reached at Bretton Woods in New Hampshire, USA.
Under this system, at the fixed exchange rate if there is disequilibrium in the balance of payments giving rise to either excess demand or supply of foreign exchange, the Central Bank of the country has to purchase and sell the required quantities of foreign exchange to eliminate the excess demand or supply.
In the case of a fixed exchange rate system, the central bank has to purchase or sell foreign exchange so that the exchange rate is maintained at the secured or fixed level. However, the fixed exchange rate could be changed through devaluation or revaluation only with permission from the IMF in case of a fundamental disequilibrium in the balance of payments.
In order to maintain the exchange rate at a given level, the central banks of different countries were required to maintain reserves of foreign currencies. The international reserve currencies are the US dollar, UK Pound Sterling, German Deutsche marks, and the Japanese Yen.
Flexible or floating exchange rate systems
The system of the exchange rate in which the exchange value of a currency is determined by the market forces of demand and supply of foreign exchange is known as a flexible or floating exchange rate system.
The flexible exchange rate system came into existence after the fall of the fixed exchange rate system in 1977. The changes in the exchange value of a currency in the foreign exchange market are known by the terms appreciation and depreciation.
For example, if the rupee-dollar trade rates become Rs.48.05 in a couple of days, the rupee would be said to have depreciated against the dollar. Alternately, assuming the rupee-dollar trade rates become Rs.46.05, the rupee would be said to have appreciated against the dollar. The changes in the exchange rate are determined by the market forces in a flexible exchange rate system.
The free market exchange rate of a currency is determined by the market influences of demand and supply of foreign exchange.
If there are two countries, India and the USA, the exchange rate of their currencies (rupee and dollar) will be determined by American demand for Indian exports and Indian demand for American exports. Indian demand for American exports implies Indian demand for US dollars. Likewise, American demand for Indian exports implies American demand for Indian rupees.
The foreign exchange reserve of a country consists of foreign currency assets held by the Central Bank, Gold holdings by the Central Bank, and Special Drawing Rights (SDRs).
For example, India’s foreign exchange reserve also consists of gold, SDRs, and foreign currency assets. Gold is not used for current transactions. It does not say anything about the balance of payment situation of the country. The net result of the external transactions of a country is indicated by changes in the foreign currency reserves and special drawing rights.
As of 20th April 2018, the value of gold was USD 21,484 million. On 19th April 2019, the value of gold went up to USD 23,303 million. In percentage terms, gold reserves went up by 8.47% during the year.
Special Drawing Rights(SDR)
In 1969, the SDR was created by the IMF to supplement the reserve assets of member nations. Between 1970 and March 2016, the IMF has created 204.1 billion SDRs which are equal to USD 285 billion. These SDRs have been allocated to member countries.
SDRs can be exchanged for freely usable currencies. The value of the SDRs based on a basket of five major currencies: the US Dollar, Euro, the Chinese Renminbi (RMB), the Japanese Yen, and UK Pound Sterling as of1st October 2016.
Reserve Tranche Position in IMF
The reserve tranche is an emergency account that IMF members can access without agreeing to conditions or paying a service fee. It is a fraction of the required quota of currency that each member country of the IMF must provide to the IMF.
The member country can utilize the reserve tranche for its purpose. The reserve tranche fraction of the quota can be accessed by the member nation at any time. A member country can borrow more than her quota but must pay back principal with interest over a three-year period.
If the amount being sought by the member nation exceeds its reserve tranche position, it becomes a credit tranche. In the beginning, a member nation’s reserve tranche is 25% of her quota, but her reserve tranche position will change according to any lending that the IMF does with its holdings of the member’s currency.
The RTP position of India as of 20th April 2018 was USD 2075 million whereas on 19th April 2019, the RTP position improved to USD 3355 million.
Sources of Data:
www.rbi.org.in (RBI bulletins and Reports).
Indian Economic Survey various years
References: IDOL Mumbai University Books
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