A Foreign exchange market is a market in which currencies are bought and sold. It is to be distinguished from a financial market where currencies are borrowed and lend. The daily turnover of the Global Foreign exchange market is presently estimated at US$ 3 trillion. Presently the Indian Foreign exchange market is the 16th largest Foreign exchange market in the world in terms of daily turnover as the BIS Triennial Survey report. As per this report the daily turnover of the Indian Foreign exchange market is US$ 34 billion in the year 2007.
Besides the OTC derivative segment of the Indian Foreign exchange market has also increased significantly since its commencement in the year 2007. During the year 2007-08 the daily turnover of the derivative segment in the Indian Foreign exchange market stands at US$ 48 billion. The growth of the Indian Foreign exchange market owes to the tremendous growth of the Indian economy in the last few years. Today India holds a significant position in the Global economic scenario and it is considered to be one of the emerging economies in the World.
The steady growth of the Indian economy and diversification of the industrial sectors in India has contributed significantly to the rapid growth of the Indian Foreign exchange market. Let us take a watch on the Indian Foreign exchange trading scenario since the early days. During 2003-04 the average monthly turnover in the Indian foreign exchange market touched about 175 billion US dollars. Compare this with the monthly trading volume of about 120 billion US dollars for all cash, derivatives and debt instruments put together in the country, and the sheer size of the foreign exchange market becomes Evident.
Since then, the foreign exchange market activity has more than doubled with the average monthly turnover reaching 359 billion USD in 2005-2006, over ten times the daily turnover of the Bombay Stock Exchange. As in the rest of the world, in India too, foreign exchange constitutes the largest financial market by far. Liberalization has radically changed India’s foreign exchange sector. Indeed the liberalization process itself was sparked by a severe Balance of Payments and foreign exchange crisis.
Since 1991, the rigid, four-decade old, fixed exchange rate system replete with import and foreign exchange controls and a thriving black market is being replaced with a less regulated, “market driven” arrangement. While the rupee is still far from being “fully floating” (many studies indicate that the effective pegging is no less marked after the reforms than before), the nature of intervention and range of independence tolerated have both undergone significant changes. With an overabundance of foreign exchange reserves, imports are no longer viewed with fear and uncertainty.
The Reserve Bank of India and its allies now intervene occasionally in the foreign exchange markets not always to support the rupee but often to avoid an appreciation in its value. Full convertibility of the rupee is clearly visible in the horizon. The effects of these developments are suspicion in the explosive growth in the foreign exchange market in India. General Features Foreign exchange market is described as an OTC (Over the counter) market as there is no physical place where the participants meet to execute their deals.
It is more an informal arrangement among the banks and brokers operating in a financing centre purchasing and selling currencies, connected to each other by telecommunications like telex, telephone and a satellite communication network, SWIFT. The term foreign exchange market is used to refer to the wholesale a segment of the market, where the dealings take place among the banks. The retail segment refers to the dealings take place between banks and their customers. The retail segment refers to the dealings take place between banks and their customers.
The retail segment is situated at a large number of places. They can be considered not as foreign exchange markets, but as the counters of such markets. The leading foreign exchange market in India is Mumbai, Calcutta, Chennai and Delhi is other centres accounting for bulk of the exchange dealings in India. The policy of Reserve Bank has been to decentralize exchanges operations and develop broader based exchange markets. As a result of the efforts of Reserve Bank Cochin, Bangalore, Ahmadabad and Goa have emerged as new centre of foreign exchange market Meaning:
The term market has been interpreted in Economics as the place where both the buyers as well as the sellers meet and they buy and or sell goods. The foreign exchange market is a place where the transactions in foreign exchange are conducted. In practical world the external transaction requires the use of foreign purchasing power i. e. foreign currency. The foreign exchange market facilitates such transactions by performing number of functions. In narrow terms foreign exchange simply means foreign currency or money transfer to any other foreign currency or money In broader terms, foreign exchange means Study of all the currencies of the different countries * How they are exchange and traded with each other * Exchange rate and how they are set * The exchange market and their performance * The participants Definition: According to Paul Einzig, “The foreign exchange market is the system in which the conversion of one national currency in to another takes place with transferring money from one country to another. ” According to Kindleberger, “It is place where foreign moneys are bought and sold. Foreign Exchange Markets in India – a brief background
The Foreign exchange trading history of India dates back to 1978, when Reserve Bank of India took a step towards allowing the banks to undertake intra-day trading in Foreign exchange. It is during the period of 1975-1992 when Reserve Bank of India, officially determined the exchange rate of rupee according to the weighted basket of currencies with the significant business partners of India. But it needs to be mentioned that there are too many restrictions on these banks during this period for trading in the Foreign exchange market. The government allowed banks to trade foreign exchange with one another.
Today over 70% of the trading in foreign exchange continues to take place in the inter-bank market. The market consists of over 90 Authorized Dealers (mostly banks) who transact currency among themselves and come out “square” or without exposure at the end of the trading day. Trading is regulated by the Foreign Exchange Dealers Association of India (FEDAI), a self-regulatory association of dealers. Since 2001, clearing and settlement functions in the foreign exchange market are largely carried out by the Clearing Corporation of India Limited (CCIL) that handles transactions 3. billion US dollars a day, about 80% of the total transactions. The liberalization process has significantly boosted the foreign exchange market in the country by allowing both banks and corporations greater flexibility in holding and trading foreign currencies. The Sod Hani Committee set up in 1994 recommended greater freedom to participating banks, allowing them to fix their own trading limits, interest rates on FCNR deposits and the use of derivative products. The growth of the foreign exchange market in the last few years has been nothing less than momentous.
In the last 5 years, from 2000-01 to 2005-06, trading volume in the foreign exchange market (including swaps, forwards and forward cancellations) has more than tripled, growing at a compounded annual rate exceeding 25%. Figure 1 shows the growth of foreign exchange trading in India between 1999 and 2006. The inter-bank foreign exchange trading volume has continued to account for the dominant share (over 77%) of total trading over this period, though there is an unmistakable downward trend in that proportion. Part of this dominance, though, results from double-counting since purchase And sales are added separately, and a single inter-bank transaction leads to a purchase as well as a sales entry. ) This is in keeping with global patterns. In March 2006, about half (48%) of the transactions were spot trades, while swap transactions (essentially repurchase agreements with a one-way transaction – spot or forward – combined with a longer- horizon forward transaction in the reverse direction) accounted for 34% and forwards and forward cancellations made up 11% and 7% respectively.
About two-thirds of all transactions had the rupee on one side. In 2004, according to the triennial central bank survey of foreign exchange and derivative markets conducted by the Bank for International Settlements (BIS (2005a)) the Indian Rupee featured in the 20th position among all currencies in terms of being on one side of all foreign transactions around the globe and its share had tripled since 1998. As a host of foreign exchange trading activity, India ranked 23rd among all countries covered by the BIS survey in 2004 accounting for 0. 3% of the world turnover.
Trading is relatively moderately concentrated in India with 11 banks accounting for over 75% of the trades covered by the BIS 2004 survey. One important policy changes pertinent to India’s foreign exchange system were brought in — rupees was made convertible in current account. This paved to the path of foreign exchange payments/receipts to be converted at market-determined exchange rate. However, it is worthwhile to mention here that changes brought in by government of India to make the exchange rate market oriented have not happened in one big bang. This process has been gradual.
Size of the Market 24 hours Market 24 hours Market Foreign exchange market is the largest financial market with a daily turnover of over USD 2 trillion. Foreign exchange markets were primarily developed to facilitate settlement of debts arising out of international trade. But these markets have developed on their own so much so that a turnover of about 3 days in the foreign exchange market is equivalent to the magnitude of world trade in goods and services. The largest foreign exchange market is London followed by New York, Tokyo, Zurich and Frankfurt.
The business in foreign exchange markets in India has shown a steady increase as a consequence of increase in the volume of foreign trade of the country, improvement in the communications systems and greater access to the international exchange markets. Still the volume of transactions in these markets amounting to about USD 2 billion per day does not compete favourably with any well-developed foreign exchange market of international repute. The reasons are not far to seek. Rupee is not an internationally traded currency and is not in great demand.
Much of the external trade of the country is designated in leading currencies of the world, Viz. , US dollar, pound sterling, Euro, Japanese yen and Swiss franc. Incidentally, these are the currencies that are traded actively in the foreign exchange market in India. 24 Hours Market The markets are situated throughout the different time zones of the globe in such a way that when one market is closing the other is beginning its operations. Thus at any point of time one market or the other is open. Therefore, it is stated that foreign exchange market is functioning throughout 24 hours of the day.
However, a specific market will function only during the business hours. Some of the banks having international network and having centralized control of funds management may keep their foreign exchange department in the key centre open throughout to keep up with developments at other centers during their normal working hours In India, the market is open for the time the banks are open for their regular banking business. No transactions take place on Saturdays. Efficiency Developments in communication have largely contributed to the efficiency of the market.
The participants keep abreast of current happenings by access to such services like Dow Jones Telerate and Teuter. Any significant development in any market is almost instantaneously received by the other market situated at a far off place and thus has global impact. This makes the foreign exchange market very efficient as if the functioning under one roof. Currencies Traded In most markets, US dollar is the vehicle currency, Viz. , the currency used to denominate international transactions. This is despite the fact that with currencies like Euro and Yen gaining larger share, the share of US dollar in the total turnover is shrinking.
Physical Markets In few centers like Paris and Brussels, foreign exchange business takes place at a fixed place, such as the local stock exchange buildings. At these physical markets, the banks meet and in the presence of the representative of the central bank and on the basis of bargains, fix rates for a number of major currencies. This practice is called fixing. The rates thus fixed are used to execute customer orders previously placed with the banks. An advantage claimed for this procedure is that exchange rate for commercial transactions will be market determined, not influenced by any one bank.
However, it is observed that the large banks attending such meetings with large commercial orders backing up, tend to influence the rates. Participants: The participants in the foreign exchange market comprise; (i) Corporates (ii) Commercial banks (iii) Exchange brokers (iv) Central banks 1. Corporates: The business houses, international investors, and multinational corporations may operate in the market to meet their genuine trade or investment requirements. They may also buy or sell currencies with a view to speculate or trade in currencies to the extent permitted by the exchange control regulations.
They operate by placing orders with the commercial banks. The deals between banks and their clients form the retail segment of foreign exchange market. In India the foreign Exchange Management (Possession and Retention of Foreign Currency) Regulations, 2000 permits retention, by resident, of foreign currency up to USD 2,000. Foreign Currency Management (Realisation, Repatriation and Surrender of Foreign Exchange) Regulations, 2000 requires a resident in India who receives foreign exchange to surrender it to an authorized dealer: a) Within seven days of receipt in case of receipt by way of remuneration, settlement of lawful obligations, income on assets held abroad, inheritance, settlement or gift: and (b) Within ninety days in all other cases. Any person who acquires foreign exchange but could not use it for the purpose or for any other permitted purpose is required to surrender the unutilized foreign exchange to authorized dealers within sixty days from the date of acquisition.
In case the foreign exchange was acquired for travel abroad, the unspent foreign exchange should be surrendered within ninety days from the date of return to India when the foreign exchange is in the form of foreign currency notes and coins and within 180 days in case of travellers cheques. Similarly, if a resident required foreign exchange for an approved purpose, he should obtain from and authorized dealer. Commercial Banks are the major players in the market. They buy and sell currencies for their clients. They may also operate on their own.
When a bank enters a market to correct excess or sale or purchase position in a foreign currency arising from its various deals with its customers, it is said to do a cover operation. Such transactions constitute hardly 5% of the total transactions done by a large bank. A major portion of the volume is accounted buy trading in currencies indulged by the bank to gain from exchange movements. For transactions involving large volumes, banks may deal directly among themselves. For smaller transactions, the intermediation of foreign exchange brokers may be sought.
Exchange brokers facilitate deal between banks. In the absence of exchange brokers, banks have to contact each other for quotes. If there are 150 banks at a centre, for obtaining the best quote for a single currency, a dealer may have to contact 149 banks. Exchange brokers ensure that the most favourable quotation is obtained and at low cost in terms of time and money. The bank may leave with the broker the limit up to which and the rate at which it wishes to buy or sell the foreign currency concerned. From the intends from other banks, the broker will be able to match the requirements of both.
The names of the counter parties are revealed to the banks only when the deal is acceptable to them. Till then anonymity is maintained. Exchange brokers tend to specialize in certain exotic currencies, but they also handle all major currencies. In India, banks may deal directly or through recognized exchange brokers. Accredited exchange brokers are permitted to contract exchange business on behalf of authorized dealers in foreign exchange only upon the understanding that they will conform to the rates, rules and conditions laid down by the FEDAI.
All contracts must bear the clause ?subject to the Rules and Regulations of the Foreign Exchanges Dealers =Association of India‘. Central Bank may intervene in the market to influence the exchange rate and change it from that would result only from private supplies and demands. The central bank may transact in the market on its own for the above purpose. Or, it may do so on behalf of the government when it buys or sell bonds and settles other transactions which may involve foreign exchange payments and receipts.
In India, authorized dealers have recourse to Reserve Bank to sell/buy US dollars to the extent the latter is prepared to transact in the currency at the given point of time. Reserve Bank will not ordinarily buy/sell any other currency from/to authorized dealers. The contract can be entered into on any working day of the dealing room of Reserve Bank. No transaction is entered into on Saturdays. The value date for spot as well as forward delivery should be in conformity with the national and international practice in this regard.
Reserve Bank of India does not enter into the market in the ordinary course, where the exchanges rates are moving in a detrimental way due to speculative forces, the Reserve Bank may intervene in the market either directly or through the State Bank of India. Settlement of Transactions Foreign exchange markets make extensive use of the latest developments in telecommunications for transmitting as well settling foreign exchange transaction, Banks use the exclusive network SWIFT to communicate messages and settle the transactions at electronic clearing houses such as CHIPS at New York.
SWIFT: SWIFT is an acronym for Society for Worldwide Interbank Financial Telecommunications, a co-operative society owned by about 250 banks in Europe and North America and registered as a co-operative society in Brussels, Belgium. It is a communications network for international financial market transactions linking effectively more than 25,000 financial institutions throughout the world that have been allotted bank identified codes. The messages are transmitted from country to country via central interconnected operating centers located in Brussels, Amsterdam and Culpeper, Virginia.
The member countries are connected to the centre through regional processors in each country. The local banks in each country reach the regional processors through the national networks. The SWIFT System enables the member banks to transact among themselves quickly (i) international payments (ii) Statements (iii) other messages connected with international banking. Transmission of messages takes place within seconds, and therefore this method is economical as well as time saving. Selected banks in India have become members of SWIFT. The regional processing centre is situated at Mumbai.
The SWIFT provides following advantages for the local banking community: 1. Provides a reliable (time tested) method of sending and receiving messages from a vast number of banks in a large number of locations around the world. 2. Reliability and accuracy is further enhanced by the built in authentication facilities, which has only to be exchanged with each counterparty before they can be activated or further communications. 3. Message relay is instantaneous enabling the counterparty to respond immediately, if not prevented by time differences. . Access is available t a vast number of banks global for launching new cross border initiatives. 5. Since communication in SWIFT is to be done using structure formats for various types of banking transactions, the matter to be conveyed will be very clear and there will not be any ambiguity of any sort for the received to revert for clarifications. This is mainly because the formats are used all ove3r the world on a standardized basis for conducting all types of banking transactions.
This makes the responses and execution very efficient at the receiving banks end thereby contributing immensely to quality service being provided to the customers of both banks (sending and receiving). 6. Usage of SWIFT structure formats for message transmission to counterparties will entail the generation of local banks internal records using at least minimum level of automation. This will accelerate the local banks internal automation activities, since the maximum utilization of SWIFT a significant internal automation level is required.
CHIPS: CHIPS stands for Clearing House Interbank Payment System. It is an electronic payment system owned by 12 private commercial banks constituting the New York Clearing House Association. A CHIP began its operations in 1971 and has grown to be the world‘s largest payment system. Foreign exchange and Euro dollar transactions are settled through CHIPS. It provides the mechanism for settlement every day of payment and receipts of numerous dollar transactions among member banks at New York, without the need for physical exchange of cheques/funds for each such transaction.
The functioning of CHIPS arrangement is explained below with a hypothetical transaction: Bank of India, maintaining a dollar account with Amex Bank, New York, sells USD 1 million to Canara Bank, maintaining dollar account with Citibank. 1. Bank of India intimate Amex Bank debuts the account of Bank through SWIFT to debit its account and transfer USD 1 million to Citibank for credit of current account of Canara Bank. 2. Amex Bank debits the account of Bank of India with USD 1 million and sends the equivalent of electronic cheques to CHIPS for crediting the account of Citibank. The transfer is affected the same day. . Numerous such transactions are reported to CHIPS by member banks and transfer affected at CHIPS. By about 4. 30 p. m. , eastern time, the net position of each member is arrived at and funds made available at Fed wire for use by the bank concerned by 6. 00 p. m. eastern time. 4. Citibank which receives the credit intimates Canara Bank through SWIFT. It may be noted that settlement of transactions in the New York foreign exchange market takes place in two stages, First clearance at CHIPS and arriving at the net position for each bank. Second, transfer of fed funds for the net position.
The real balances are held by banks only with Federal Reserve Banks (Fed funds) and the transaction is complete only when Fed funds are transferred. CHIPS help in expediting the reconciliation and reducing the number of entries that pass through Fed wire. A CHAP is an arrangement similar to CHIPS that exists in London. CHAPS stands for Clearing House Automated Payment System. Fed wire the transactions at New York foreign exchange market ultimately get settled through Fed wire. It is a communication network that links the computers of about 7000 banks to the computers of federal Reserve Banks.
The fed wire funds transfer system, operate by the Federal Reserve Bank, are used primarily for domestic payments, bank to bank and third party transfers such as interbank overnight funds sales and purchases and settlement transactions. Corporate to corporate payments can also be made, but they should be affected through banks. Fed guarantees settlement on all payments sent to receivers even if the sender fails. Year | Purchase | Sell | Net | ( In US$ billion) | 1995-96 | 3. 6 | 3. 9 | -0. 3 | 1996-97 | | 11. 2 | 3. 4 | 7. 8 | 1997-98 | 15. 1 | 11. 2 | 3. 9 | 998-99 | 28. 7 | 26. 9 | 1. 8 | 1999-00 | 24. 1 | 20. 8 | 3. 3 | 2000-01 | 28. 2 | 25. 8 | 2. 4 | 2001-02 | 22. 8 | 15. 8 | 7. 0 | 2002-03 | 30. 6 | 14. 9 | 15. 7 | 2003-04 | 55. 4 | 24. 9 | 30. 5 | 2004-05 | 31. 4 | 10. 6 | 20. 8 | 2005-06 | 15. 2 | 7. 1 | 8. 1 | 2006-07 | 24. 5 | 0 | 24. 5 | | Functions of foreign Exchange Market The foreign exchange market is a market in which foreign exchange transactions take place.
The foreign exchange market performs mainly three functions * Transferring the purchasing power * Provision of credit for foreign trade and Furnishing facilities for hedging for foreign exchange risks Transfer of Purchasing Power The most important function is the transfer of purchasing power from one country to another and from one national currency to another. The purchasing power is transferred through the use of credit instruments. The main credit instrument is used for the transferring the purchasing power is the telegraphic transfer (TT) of the cabled order by one bank (in country A) to its correspondent abroad (in country B) to pay B funds out of its deposit account to its designated account or order.
The telegraphic transfer is simply a sort of cheque, which is wired or radioed rather than sent by post. Purchasing power may also be transferred through bank drafts. The Primary function of a foreign exchange market is the transfer of purchasing power from one country to another and from one currency to another. The international clearing function performed by foreign exchange markets plays a very important role in facilitating international trade and capital movement. Provision of credit The foreign exchange market also provides credit for foreign trade. Like all he traders, international trade also requires credit. It takes time to move the goods from seller to purchaser and during this period, the transaction must be financed. When the exporter does not need credit for the manufacture of export goods, credit is necessary for the transit of goods. When the special credit facilities of the foreign exchange market are used, the foreign exchange department of a bank or the bill market is used; the foreign exchange department of the bank or the bill market of one country or the other extends the credit facilities to finance the foreign trade.
The credit function performed by foreign exchange markets also plays a very important role in the growth of foreign trade, for international trade depends to a great extent on credit facilities. Exporters may get pre shipment and post shipment credit. Credit facilities are available also for importers. The Euro dollar market has emerged as a major international credit market. Provision of Heeding Facilities The other important of the foreign exchange market is to provide hedging facilities.
Heeding refers to covering of foreign trade risks, and it provides a mechanism to exporters and importers to guard themselves against losses arising from fluctuations in exchange rates. Imports, opening of LC Advance bills, Bills for collection Import loan and guarantees Imports, opening of LC Advance bills, Bills for collection Import loan and guarantees Furnishing facilities for hedging foreign exchange risks The foreign exchange market by providing facilities of buying and selling at spot or forward exchange, enables the exporters and importers to hedge their exchange risks arising from change in the foreign exchange rate.
The forward market in exchange also enables those banks, which are unlikely to run any considerable exchange position to cover their commitments. Exports PRE/POST shipment Advance Exports guarantees LC’S and bill for collection Exports PRE/POST shipment Advance Exports guarantees LC’S and bill for collection Exchange dealings, Rate computation Nastro / Vastro accounts Forward contacts, derivatives exchange Position and cover Position cover Exchange dealings, Rate computation Nastro / Vastro accounts Forward contacts, derivatives exchange Position and cover Position cover
Remittances, issues of DD, MT, TT, Cheques , Sale of Foreign Currency notes, NR deposits Remittances, issues of DD, MT, TT, Cheques , Sale of Foreign Currency notes, NR deposits Statistics, submission of returns, Collection of credit Information Statistics, submission of returns, Collection of credit Information Structure of foreign Exchange Market Foreign exchange management Act Central Govt. R. B. I Authorized Person FEDAI Foreign exchange management Act Central Govt. R. B. I Authorized Person FEDAI Authorised Money Changes Authorised Dealer Full fledged Restricted Foreign Exchange Management Act (FEMA)
The Foreign Exchange Management Act (FEMA) is a 1999 Indian law “to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India”. It was passed in the winter session of Parliament in 1999, replacing the Foreign Exchange Regulation Act (FERA). This act seeks to make offenses related to foreign exchange civil offenses. It extends to the whole of India. ,[1] replacing FERA, which had become incompatible with the pro-liberalisation policies of the Government of India.
It enabled a new foreign exchange management regime consistent with the emerging framework of the World Trade Organisation (WTO). It is another matter that the enactment of FEMA also brought with it the Prevention of Money Laundering Act of 2002, which came into effect from 1 July 2005. Need for its management The buying and selling of foreign currency and other debt instruments by businesses, individuals and governments happens in the foreign exchange market. Apart from being very competitive, this market is also the largest and most liquid market in the world as well as in India. 4] It constantly undergoes changes and innovations, which can either be beneficial to a country or expose them to greater risks. The management of foreign exchange market becomes necessary in order to mitigate and avoid the risks. Central banks would work towards an orderly functioning of the transactions which can also develop their foreign exchange market. [5] Whether under FERA or FEMA’s control, the need for the management of foreign exchange is important. It is necessary to keep adequate amount of foreign exchange reserves, especially when India has to go in for imports of certain goods.
By maintaining sufficient reserves, India’s foreign exchange policy marked a shift from Import Substitution to Export Promotion Main Features – Activities such as payments made to any person outside India or receipts from them, along with the deals in foreign exchange and foreign security is restricted. It is FEMA that gives the central government the power to impose the restrictions. – Restrictions are imposed on people living in India who carry out transactions in foreign exchange, foreign security or who own or hold immovable property abroad. Without general or specific permission of the Reserve Bank of India, FEMA restricts the transactions involving foreign exchange or foreign security and payments from outside the country to India – the transactions should be made only through an authorised person.
– Deals in foreign exchange under the current account by an authorised person can be restricted by the Central Government, based on public interest. – Although selling or drawing of foreign exchange is done through an authorised person, the RBI is empowered by this Act to subject the capital account transactions to a number of restrictions. People living in India will be permitted to carry out transactions in foreign exchange, foreign security or to own or hold immovable property abroad if the currency, security or property was owned or acquired when he/she was living outside India, or when it was inherited to him/her by someone living outside India. – Exporters are needed to furnish their export details to RBI. To ensure that the transactions are carried out properly, RBI may ask the exporters to comply to its necessary requirements Authorised Dealer
In terms of Section 10 (1) of the Foreign Exchange Management Act, 1999, the Reserve Bank, on an application, may authorise any person to be known as an authorised person, to deal in foreign exchange as an authorised dealer, money changer or off-shore banking unit or in any other manner as it deems fit. 2. Currently, Reserve Bank issues licences to authorised dealers (banks authorised to deal in foreign exchange) and Full Fledged Money Changers. Licences are also granted to financial and other institutions to carry out specific foreign exchange transactions related to their business / activities. . With the progressive liberalisation in foreign exchange related transactions, a large segment of the population can now undertake a variety of current account transactions on their individual accounts, without approaching the Reserve Bank.
With a view to providing adequate foreign exchange facilities to common persons, to widen the scope of activities which the Authorised Persons are eligible to undertake, to increase the number of entities that are eligible to sell foreign exchange to the public or their day-to-day current account transactions and to ensure efficient customer service through competition, an internal group was constituted to study the related issues. The Group was required to make recommendations keeping in view the enhanced as well as wider access and accompanying safeguards, especially reporting requirements. The Report “Licensing Policy for Authorised Persons – Liberalisation” was placed on the Reserve Bank website on December 1, 2005, inviting feedback from the public. 2. Classification of Persons Authorised to deal in the foreign exchange Sr.
No. | Present category | Entities | Revised category | Major Activities | 1. | Authorised Dealer | ? Commercial Banks ? State Co-op Banks ? Urban Co-op Banks | Authorised Dealer – Category – I | All current and capital account transactions according to RBI directions issued from time-to-time. (No Change). | 2. | – | ? Upgraded FFMCs ? Co-op. Banks ? Regional Rural Banks (RRBs)? Others | Authorised Dealer – Category – II | Specified non-trade related current account transactions as at paragraph 3 below as also all the activities permitted to Full Fledged Money Changers.
Any other activity as decided by the Reserve Bank. | 3. | – | ? Select Financial and other Institutions | Authorised Dealer – Category – III | Transactions incidental to the foreign exchange activities undertaken by these institutions. (No Change) | 4. | Full Fledged Money Changers (FFMCs) | ? Dept. of Posts ? Urban Co-op. Banks ? Other FFMCs | FFMCs | Purchase of foreign exchange and sale for private and business visits abroad. (No Change) | Foreign exchange dealer association in India
The FEDAI was set up in 1958 as an association of banks dealing in foreign exchange in India called Authorised Dealers – AD’s. it is a self-regulatory body and is incorporated u/s 25 of the ICA, 1956. The major activities include: Framing of rules governing the conduct of foreign exchange business between banks Transaction between banks and the public and liaison with RBI for reforms and development of the foreign exchange market Functions are as follows: * Frame guidelines and rules for foreign exchange business * Training f bank personnel in the areas of foreign exchange business * Accrediatation of foreign exchange brokers and periodic review of their operations * They also advice the RBI regarding licensing of new brokers * Advising / Assiting member banks in settling issues / matters in their dealings. They provide a standarised dispute settlement process for all market participants. * Represent member banks in discussion with Government / RBI / Other Bodies and provide a common a common platform for AD’s to intract with the government and RBI * Announcement of daily and periodical rates to member banks.
At the end of each calendar month they provide a schedule of forward rates to be used by AD’s for revaluating foreign currency denominated assets and liabilities * Announcement of ‘ spot date’ at the start of each trading day ensure uniformity in settlement between different market participants * Circulating guidelines for quotation rates, charging of commission etc. by AD’s to their customers and by brokers for interbank transactions MONEY CHANGERS IN FOREIGN EXCHANGE Attention is invited to the amendments made in the Foreign Exchange Regulation Act, 1947 (VII of 1947) vide Finance Bill, 1999, as reproduced in Annexure ‘A’ to this circular.
The amendments empower the State Bank to regulate the foreign exchange business of “Money Changers”. While the longer-run strategy of granting licences, formulating rules and regulations for the conduct of business and maintaining records and supplying information to the State Bank is to be developed by the State Bank in consultation with bankers, money changers and representatives of the private sector, the present speculative activity in the “kerb market” has necessitated the adoption and enforcement of the following immediate measures.
These instructions are being issued in exercise of the power vested in the State Bank by the Foreign Exchange Regulation Act and shall become effective immediate. No person or institution that does not hold a valid licence from the State Bank for dealing in foreign exchange as “money changer” or as “authorized dealer” shold engage in the business of buying and selling of foreign exchange in any place anywhere in Pakistan. Those who have valid licence as “money changer” under the existing procedures can continue to conduct foreign exchange business by strictly adhering to the ules and regulations and instructions issued by the State Bank of Pakistan from time to time. Any violation of the instructions would make them liable for action under the relevant laws. In supersession of the instructions laid down in paragraph 6, Chapter II of the Foreign Exchange Manual as amended from time to time, the Authorized Money Changers shall conduct business, inter-alia. In accordance with the following instructions:- Authorized Money Changers’ activities will be restricted to purchase and sale of foreign currency notes and coins only. They shall not buy or sell travellers cheques.
No transfer of funds abroad shall be made through illegal channels such as “Hundi system”. All transfer of funds shall take place through banking channels, following the instructions given to the banks from time to time for the purpose. The Authorized Money Changers shall prominently display the rates for purchase and sale of major currencies daily at their places of business. The Money Changers shall maintain permanent books of accounts to record all sales and purchases and every transaction must be recorded in such books on a daily basis. Failure to maintain such records would prompt action by the State Bank of Pakistan.
State Bank inspection teams can examine records. Books and accounts at any time and those must be made available to the inspectors without hesitancy or hindrance. Dealing between Authorized Money Changers and customers should be supported by receipts/vouchers for all transactions. A transaction done without a proper receipt will be treated as illegal transactions. The financial institutions, including commercial banks, are prohibited from selling or purchasing foreign exchanges from the money changers, on their own account or on the account of their clients except when they may be explicitly allowed by the State Bank.
Similarly, no public sector institution and no government agency shall sell or purchase foreign exchange from the market other than the inter-bank market. Diplomats and home-based members of Diplomatic Missions and expatriate employees of international organizations should also sell and purchase foreign exchange only in the inter-bank market. A weekly statement of sales and purchases, for weeks ending on the 8th, 15th, 22nd and the last day of each month will be submitted to the area control office of the State Bank within three days in the proforma attached as Annexure B.
In Section 2, after sub-section (aa) the following new sub-section shall be added, namely: – “(ab)” authorized money changer” means a person for the time being authorized under section 3A to deal in foreign currency notes, bank notes, coins and travellers cheques”. i. In section 3, sub-section(5) shall be ommitted. ii. After section 3, the following new sections shall be inserted, anmely;- “3A Authorised Money Changers in foreign exchange: – 1.
The State Bank may, on application made to it in this behalf, and on payment of a fee prescribed by it, from time to time, authorize any person to deal in foreign currency notes, bank notes, coins and travellers cheques. 2. The power conferred under sub-section(1) shall be exercised on the basis of criteria prescribed, and recommendations made, by a committee consisting of such official and non-official representatives as may be nominated by the State Bank. 3. An authorization made under this section may be for a specific period of time, which may be renewed thereafter.
An authorized money changer shall, in all his dealings under the authorization, comply with such general or special directions or instructions as the State Bank may, from time to time, think fit to give including those for supply of data, the rate and code of conduct in doing business. Failure to comply with the instructions may lead to suspension of the licence or other actions as necessary Reserve Bank of India Act, 1934 The RBI of India performs both the traditional functions of a central bank and a variety of developmental and promotional functions.
The RBI Act, 1934, confers upon it the powers to act as not issuing authority, banker‘s bank and banker to the Government. Reserve Bank as Note Issuing Authority The Currency of our country consists of one rupee notes and coins (including subsidiary coins) issued by the Government of India and bank notes issued by the Reserve Bank. As required by section 38 of the RBI act, Government puts into circulation one rupee coins and notes through Reserve Bank only. The Reserve Bank has the sole right to issue bank notes in India. The notes issued by the Reserve Bank and the one rupee notes and coins issued by the
Government are unlimited legal tender. Reserve Bank also bears the responsibility of exchanging notes and coins into those of other denominations as required by the public. As required by the Reserve Bank of India Act, the issue of notes and the general banking business of the Bank are undertaken by two separate departments of the Bank. The Issue Department is responsible for the issue of new notes. It keeps its assets, which form the backing for the note issue, quite separate from the assets of the Banking Department. Exchange Control in India Any transaction in foreign Exchange is governed by Foreign Exchange Management ACT 1999.
The FERA had its origin by defence of India rules (DIR) 1935. This control was exercised in order to ensure the foreign exchange particularly due to severe constraints on exchange reserve due to Second World War. Later on 23 March 1947 this rule became in the State Book as Foreign Exchange Regulation Act 1947. Later this act modified with certain amendments in 1973 and become effective from 01. 01. 1974. Further relaxation of this affect was effected since 1994. The same was repealed from 1st June, 2000 and all foreign exchange transactions from this date will be governed by the provisions of the Foreign Exchange Management Act 1999.
As per the foreign exchange Management Act 1999 the Reserve Bank of India principally controls the movement of the Foreign Exchange of the country. As per sec 11 (1) of FEMA, the Reserve Bank may for the purpose of securing compliance with the provisions of this act and any rules, regulations, notification or directions made there under give to the authorized person any direction in regard to making of payment or the doing or desist from doing any act relating to foreign security.
As per Section 11(2) of the act the Reserve Bank may for the purpose of ensuring the compliance with the provisions of the Act or of any rules regulations notification or order made there under direct any authorized person to furnish such information in such manners as it deem fit. As per Section 11 (3) where any authorized person contravenes any direction given by the Reserve Bank under this act or fail to file any return as directed by the Reserve Bank, the Reserve Bank may fter giving reasonable opportunities of being heard impose on the authorized person a penalty which may extent to ten thousand rupees and in the case of continuing contravention with an additional penalty which may extend to two thousand rupees for every day during which such contravention continues. The Exchange control Manual published by Reserve Bank if India gives various directives to authorized dealers in foreign exchange. The authorized dealers in foreign exchange are expected to strictly follow the directives of RBI in exchange control manual without any deviation. Development of Forex Markets: Indian Experience
Evolution of Indian Foreign ExchangeMarket Market players in foreign exchange became active in the seventies, consequent upon the collapse of Bretton Woods Agreement. However, India was somewhat insulated since stringent exchange controls prevailed and banks were required to undertake only cover operations and maintain a ‘square’ or ‘near square’ position at all times. In 1978, the RBI allowed banks to undertake intra-day trading in foreign exchange and as a consequence, the stipulation of maintaining `square’ or `near square’ position was to be complied with only at the close of business hours each day.
This perhaps marks the beginning of forex market in India. As opportunities to make profits began to emerge, the major banks started quoting two-way prices against the rupee as well as in cross currencies and gradually, trading volumes began to increase. During the period, 1975-92 the exchange rate regime in India was characterised by daily announcement by the RBI of its buying and selling rates to Authorised Dealers (ADs) for merchant transactions.
Given the then prevalent RBI’s obligation to buy and sell unlimited amounts of the intervention currency arising from the banks’ merchant purchases, its quotes for buying/selling effectively became the fulcrum around which the market was operated. The RBI performed a market-clearing role on a day-to-day basis, which naturally introduced some variability in the size of reserves. Incidentally, certain categories of current and capital account transactions on behalf of the Government were directly routed through the reserves account.
Recommendations of High Level Committee on Balance of Payments The recommendations of the High Level Committee on Balance of Payments (Chairman: Shri C. Rangarajan) provided the basic framework for policy changes in external sector, encompassing exchange rate management and, current and capital account liberalisation. The Report indicated the transition path also. Accordingly, the Liberalised Exchange Rate Management System involving dual exchange rate system was instituted in March 1992, no doubt, in conjunction with other measures of liberalisation in the areas of trade, industry and foreign investment.
The dual exchange rate system was essentially a transitional stage leading to the ultimate convergence of the dual rates made effective from March 1, 1993. This unification of exchange rates brought about the era of market determined exchange rate regime of rupee, based on demand and supply in the forex market. It also marks an important step in the progress towards current account convertibility, which was finally achieved in August 1994 by accepting Article VIII of the Articles of Agreement of the International Monetary Fund.
The appointment of a 14 member Expert Group on Foreign Exchange (Sodhani Committee) in November 1994 was a follow up step to the above measures, for the development of the foreign exchange market in India. The Group studied the market in great detail and in its Report of June, 1995 came up with far-reaching recommendations to develop, deepen and widen the forex market as also to introduce various products, ensure risk management and enable efficiency in the forex market by removing restrictions, introducing new products and tightening internal control and risk management systems.
Implementation of the Recommendations of Sodhani Committee The Sodhani Committee had made 33 recommendations and of these, 25 recommendations called for action on the part of the RBI. RBI has accepted and implemented in full or to some degree, 20 out of the 25 recommendations. In the process, the banks have been accorded significant initiative and freedom to participate in the forex market.
These include: freedom to fix net overnight position limit and gap limits although RBI is formally approving these limits, replacing the system of across-the board or RBI prescribed limits; freedom to initiate trading position in the overseas markets; freedom to borrow or invest funds in the overseas markets (up to 15 per cent of Tier I Capital unless otherwise approved); freedom to determine the interest rates (subject to a ceiling) and maturity period of Foreign Currency Non-Resident (FCNR) deposits (not exceeding three years); exempting nter-bank borrowings from statutory pre-emptions (subject to minimum statutory requirement of 3 per cent and 25 per cent in respect of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) for the total net liabilities respectively); and freedom to use derivative products for asset-liability management. Corporates also have been accorded noticeable freedom to operate in the forex market. Thus, they are permitted to hedge anticipated exposures though this facility has been temporarily suspended after the Asian crisis.
Exchange Earners Foreign Currency (EEFC) account eligibility has been increased and the permissible end-uses widened. They were given freedom to cancel and rebook forward contracts, though currently due to the Asian crisis effect, freedom to rebook cancelled contracts is suspended while rollover is permissible. Banks can, however, offer cross-currency options on back-to-back basis. Corporates can also avail of lower cost option strategies like range forwards and ratio range forwards and others as long as they do not end up as net writers of options.
Also available are some degrees of freedom to manage exposures in External Commercial Borrowings without having to approach authorities for hedging permission, and to access swaps with rupee as one of the currencies to hedge longer term exposures. The Committee recognised that improvements in internal controls and market strategies go hand in hand with liberalisation and towards this end, RBI accepted and implemented several suggestions of the Sodhani Committee.
These include: revamping internal control guidelines of the RBI to banks and making them available to corporates as well; putting in place appropriate market intervention strategies to deal with market developments; adopting internationally accepted documentation standards; framing comprehensive risk management guidelines for banks; adopting Basle Committee norms for computing foreign exchange position limits and recommending capital backing for open positions; and setting up a foreign exchange market committee to discuss market issues and suggest solutions.
Recommendation on publishing critical data on forex transactions, has been implemented, and in fact the standards of disclosure by RBI are considered to be very high now. A few recommendations of the Sodhani Committee which have not been implemented include, inducting Development Financial Institutions (DFIs) as full-fledged Authorised Dealers (ADs), setting up a forex clearing house, legally recognising netting of settlements, permitting corporates to undertake margin trading and setting up of off-shore banking units in Mumbai.
Let me briefly dwell on each of these issues. Induction of DFIs as full-fledged ADs is linked to future role of development financial institutions and indeed the approach to universal banking. Till then, their activity in the forex market can only be incidental to what they are permitted to do as a DFI. The position on setting up of a Forex Clearing House and the position on setting up of off-shore banking units will be detailed in the latter part of this address.
Margin trading by its very nature is considered to be potentially speculative, and therefore, has not been seriously considered so far for implementation. Recommndations of Tarapore Committee Tarapore Committee on Capital Account Convertibility, 1997, had recommended a number of measures relating to financial markets, especially forex markets. Some of the measures undertaken in regard to forex may fall short of the indicative quantitative limits given in the Report, but the purpose and the spirit of such measures are in line with the recommendations of the committee.
Among such various liberalisation measures undertaken are those relating to foreign direct investment, portfolio investment, investment in Joint Ventures/wholly owned subsidiaries abroad, project exports, opening of Indian corporate offices abroad, raising of EEFC entitlement to 50 per cent, forfaiting, allowing acceptance credit for exports, allowing FIIs to cover forward their exposures in debt and part of their exposures in equity market, etc. In respect of the recommendations of the Committee to develop financial markets also, significant progress has been made.
In the money market, as part of improving the risk management, recently, guidelines for interest rate swaps and FRAs have been issued to facilitate hedging of interest rate risks and orderly development of the fixed income derivatives market. Measures have also been undertaken to further develop the Government securities market. Permission has also been given to banks fulfilling certain criteria to import gold for domestic sale. As will be explained later in this address, this aspect of gold policy is a major step in bringing off-market forex transactions into forex markets by officialising import of gold.
Efforts are also underway to expedite the implementation of the announcement made in October 1997 by RBI to permit SEBI registered Indian fund managers including Mutual Funds to invest in overseas markets subject to SEBI guidelines. Features of Forex Market There are several features of Indian forex market which, are briefly stated as under. Participants The foreign exchange market in India comprises of customers, Authorised Dealers (ADs) in foreign exchange and Reserve Bank of India. The ADs are essentially banks authorised by RBI to do foreign exchange business.
Major public sector units, corporates and other business entities with foreign exchange exposure, access the foreign exchange market through the intermediation of ADs. The foreign exchange market operates from major centres – Mumbai, Delhi, Calcutta, Chennai, Bangalore, Kochi and Ahmedabad, with Mumbai accounting for the major portion of the transactions. Foreign Exchange Dealers Association of India (FEDAI) plays an important role in the forex market as it sets the ground rules for fixation of commissions and other charges and also involves itself in matters of mutual interest of the Authorised Dealers.
The customer segment is dominated by Indian Oil Corporation and certain other large public sector units like Oil and Natural Gas Commission, Bharat Heavy Electricals Limited, Steel Authority of India Limited, Maruti Udyog and also Government of India (for defence and civil debt service) on the one hand and large private sector corporates like Reliance Group, Tata Group, Larsen and Tubro, etc. , on the other. Of late, the Foreign Institutional Investors (FIIs) have emerged as a major component in the foreign exchange market and they do account for noticeable activity in the market. Segments
The foreign exchange market can be classified into two segments. The merchant segment consists of the transactions put through by customers to meet their transaction needs of acquiring/offloading foreign exchange, and inter-bank segment encompassing transactions between banks. At present, there are over 100 ADs operating in the foreign exchange market. The banks deal among themselves directly or through foreign exchange brokers. The inter-bank segment of the forex market is dominated by few large Indian banks with State Bank of India (SBI) accounting for a large portion of turnover, and a ew foreign banks with benefit of significant international experience. Market Makers In the inter-bank market, SBI along with a few other banks may be considered as the market-makers, i. e. , banks which are always ready to quote two-way prices both in the spot and swap segments. The market makers are expected to make a good price with narrow spreads both in the spot and the swap segments. The efficiency and liquidity of a market are often gauged in terms of bid-offer spreads. Wide spreads are an indication of an illiquid market or a one way market or a nervous condition in the market.
In India, the normal spot market quote has a spread of 0. 5 to one paisa, while the swap quotes are available at 2 to 4 paise spread. At times of volatility, the spread widens to 5 to 10 paise. Turnover The turnover in the Indian forex market has been increasing over the years. The average daily gross turnover in the dollar-rupee segment of the Indian forex market (merchant plus inter-bank) was in the vicinity of US $ 3. 0 billion during 1998-99. The daily turnover in the merchant segment of the dollar-rupee segment of foreign exchange market was US $ 0. billion, while turnover in the inter-bank segment was US $ 2. 3 billion. Looking at the data from the angle of spot and forward market, the data reveals that the average daily turnover in the spot market was around US $ 1. 2 billion and in the forward and swap market the daily turnover was US$ 1. 8 billion during 1998-99. Forward Market The forward market in our country is active up to six months where two way quotes are available. As a result of the initiatives of the RBI, the maturity profile has since recently elongated and there are quotes available up to one year.
In India, the link between the forward premia and interest rate differential seems to work largely through leads and lags. Importers and exporters do influence the forward markets through availment of/grant of credit to overseas parties. Importers can move between sight payment and 180 days usance and will do so depending on the overseas interest rate, local interest rate and views on the future spot rate. Similarly, importers can move between rupee credit and foreign currency credit. Also, the decision, o hedge or not to hedge exposure depending on expectations and forward premia, itself affects the forward premia as also the spot rate. Exporters can also delay payments or receive funds earlier, subject to conditions on repatriation and surrender, depending upon the interest on rupee credit, the premia and interest rate overseas. Similarly, decision to draw bills on sight/usance basis is influenced by spot market expectations and domestic interest rates. The freedom to avail of pre/post-shipment credit in forex and switch between rupee and foreign currency credit has also integrated the money and forex markets.
Further, banks were allowed to grant foreign currency loans out of FCNR (B) liabilities and this too facilitated integration as such foreign currency demarcated loans did not have any use restriction. The integration is also achieved through banks swapping/unswapping FCNR (B) deposits. If the liquidity is considerable and call rates are easy, banks consider deployment either in forex, government or money/repo market. This decision also affects the premia. Gradually, with the opening up of the capital account, the forward premia is getting aligned with the interest rate differential.
However, the fact remains that free movement in capital account is only a necessary condition for full development of forward and other forex derivatives market. The sufficient condition is provided by a deep and liquid money market with a well-defined yield curve in place. Developing a well integrated, consistent and meaningful yield curve requires considerable market development in terms of both volume and liquidity in various time and market segments. No doubt, the integration between the domestic market and the overseas market operates more often through the forward market.
This integration is facilitated now by allowing ADs to borrow from their overseas offices/correspondents and invest funds in overseas money market up to the same amount. Data on Forex Markets The RBI publishes daily data on exchange rates, forward premia, foreign exchange turnover etc. in the Weekly Statistical Supplement (WSS) of the RBI Bulletin with a lag of one week. The movement in foreign exchange reserves of the RBI on a weekly basis are furnished in the same publication. The RBI also publishes data on Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER), RBI’s purchases and sales in the foreign xchange market along with outstanding forward liabilities on reserves etc. in the monthly RBI Bulletin with a time lag of one month.
Since July 1998, the Reserve Bank of India started publishing the 5-country trade based NEER and REER in addition to 36-country NEER and REER in the RBI Bulletin. Way ahead of many developing and industrial country central banks, the RBI has been publishing the size of its gross intervention (purchase and sale) each month and its net forward liability position. Linkages among Markets and Policy Responses Since the introduction of the reform measures, broad segments of the market, viz. money market, Government securities market, capital market, and foreign exchange market, have exhibited some degree of integration. The markets have become inter-linked to the extent participants can move freely from one market to another. The linkages between the forex market and domestic markets essentially depend on the foreign currency liabilities and assets banks can maintain and the extent and degree to which they are swapped into rupees and vice versa. Thus, on the liabilities side, we have foreign currency borrowings from overseas offices/correspondents, borrowings for lending to exporters, FCNR-B deposits and EEFC/RFC deposits.
These funds can be used either for raising rupee resources through swaps or for lending in foreign currency. A significant step was taken by the RBI when it allowed banks to lend in foreign currency to companies in India for any productive purpose without linking to exports or import financing. This effectively meant that companies had the choice to borrow either in foreign currency or rupees depending on the cost, taking into account both exchange risk and interest cost. Thus, companies can substitute rupee credit for foreign credit freely. Similarly, exporters also have the ability to substitute rupee credit for foreign currency credit.
The integration of foreign exchange market with other markets like money market and government securities market meant closer co-ordination of monetary and exchange rate policy. For instance, in January 1998, when the foreign exchange market came under severe pressure, Reserve Bank of India undertook strong monetary policy measures leading to sharp withdrawal of liquidity and increase in short-term interest rates. The impact of monetary management was such that by February 1998 orderly conditions were restored in the forex market and normalcy was attained in money market.
At times of highly speculative exchange rate movements, simultaneous intervention in foreign exchange and domestic market is called for to have an immediate strong effect on both the exchange rate and money market conditions. Thus, to maximise the effectiveness of the foreign exchange market intervention as a signaling device, it is also carefully co-ordinated with monetary management. These co-ordinated intervention strategies require close day-to-day monitoring of the supply of banking system liquidity and an active use of open market operations to adjust liquidity conditions.
However, driving a wedge between money and forex markets at times, becomes necessary when it is felt that liquidity conditions may put pressure on the forex market, while tightening liquidity could hurt the real sector. The recent initiatives of RBI to usher in the rupee interest rate derivatives should facilitate the development of rupee term money market and define the rupee yield curve across maturities. Besides bringing about greater integration of the money and forex markets, the move has set the stage for the take-off of rupee-foreign currency derivatives.
Unique Features of Indian Forex Market Gold Policy Liberalisation of gold policy had an indirect but, significant impact on the forex market. The logic behind the changes in the gold policy was explained in my earlier speeches on the subjects of capital flight and gold. The major thrust of the liberalisation process in gold policy centred around opening up of additional channels of import, a logical consequence of which was the reduction in differential between the international and domestic price of gold.
The price differential of gold was as high as 67 per cent in 1992 when the structural reform process was initiated; it fell to 6 per cent by the end of 1998. The unofficial market in foreign exchange which drew its sustenance from the illegal trade in gold went out of existence as an immediate fall out. In essence, the import of gold which was largely on unofficial account in earlier years, was officialised, and correspondingly the foreign exchange used to finance such unofficial imports was also officialised, mainly through enhanced flow under invisibles account.
NRI Deposits Various deposit schemes have been designed from time to time to suit the requirements of non-resident Indians (NRIs). Currently, we have three NRI deposit schemes, viz. , Non Resident External (NRE) account which is denominated in rupees, Non Resident Non Repatriable (NRNR) account, which is non-repatriable rupee account except for the interest component which is repatriable, and the Foreign Currency Non Resident (Bank) (FCNR-B) account which is a foreign currency account. Banks have also been allowed considerable freedom in deployment of these funds.
Of interest to forex markets is the operation of FCNR-B scheme, because banks have to bear exchange risk. Banks either hold these deposits in foreign currency investing them abroad or lend in foreign currency to corporates in India or swap into rupees and lend to Indian corporates in rupees. When corporates borrow in foreign currency, there is an inflow into the market but there may be hedging by corporates. When banks swap into rupees and lend, there is an impact on forex markets but forward premia and lending rates in rupees are critical.
Thus, tracking the use of FCNR (B) deposits is essential in appreciating forex markets. Public Enterprises Operations of large public sector undertakings have a significant impact especially on spot market, and their procedures for purchase or sale of foreign currency also impact on market sentiments. To this end, and in order to enable Public Sector Enterprises (PSEs) to equip themselves in formulating an approach to management of foreign currency exposure related risks, the Government of India had set up a Committee in January 1998.
The Report of the Committee explicitly brings out the approach that is appropriate for risk management with reference to the foreign currency exposure of PSEs. PSEs with large volume of foreign exchange exposure were also advised by the Committee to consider setting up Dealing Room for undertaking treasury functions both for rupee and foreign exchange which include management of rupee resources, foreign exchange transactions and risk management.
Adoption of approaches recommended would enable the PSEs to spread their demand and supply in forex market, in a non-disruptive way to the benefit of both the PSE concerned and functioning of forex market in India. Off-shore Banking Units The setting up of Off-shore banking units at this advanced stage of financial liberalisation in our country is considered by many to be unnecessary and that the time for an offshore banking unit has gone. In a country of our size, the issue of linkages between off-shore sector and the domestic sector is undoubtedly an important one.
We need to make a clear distinction between the financial issues and the non-financial issues on the subject. From the central bank’s perspective, designing appropriate regulatory framework is important and the most important issue is ensuring of a firewall between the off-shore transactions and domestic transactions. Physical location is not relevant, especially when deposit taking and cash transactions are not permitted in off-shore business. In fact, we do not have a good model of real off-shore centre in a country with capital controls.
Confederation of Indian Industry (CII) with assistance from the Government of Maharashtra is engaged in a detailed study of the various issues to make recommendations to the RBI and the Government of India. Clearing House The idea of establishing a Foreign Exchange Clearing House (FXCH) in India was mooted in 1994. The Expert Group on Foreign Exchange Markets in India also recommended introduction of foreign exchange clearing and making netting legally enforceable. The Scheme was conceived as multilateral netting arrangement of inter-bank forex transactions in US dollar.
The membership would be open to all ADs in foreign exchange participating in the inter-bank foreign exchange market. RBI will also be a participating member. The net position of each bank arrived at the end of the trading day would be settled through a Clearing Account to be maintained by RBI. It was recognised that a substantial reduction in number of Nostro account transactions of the participating banks would lead to economy in settlement cost and efficiency in settlement.
Other benefits include easing the process of reconciliation of Nostro accounts balances by banks, reduction in size of credit and liquidity exposure of participating banks and hence systemic risk, etc. The long-term objective is to establish clearing house as a separate legal entity with risk and liquidity management features, infrastructure and operational efficiency akin to other leading clearing systems. However, to start with, we may aim at commencing the operation with such minimum modification to the scheme as may be necessary. For the resent, the focus areas are legal, risk and liquidity aspects and operational infrastructure, and all these issues are under examination in the RBI. Role of FEDAI In a regime where exchange rates were fixed and there were restrictions on outflow of foreign exchange, the RBI encouraged the banks to constitute a self regulatory body and lay down rules for the conduct of forex business. In order to ensure that all the banks participated in the arrangement, the RBI placed a condition while issuing foreign exchange licence that every licensee agree to be bound by the rules laid down by the banker’s body – the FEDAI.
FEDAI also accredited brokers through whom the banks put through deals. There is increasing emphasis now on competition, and fixing or advising charges by professional bodies is being viewed with disfavour and often treated as a restrictive trading practice. It is currently argued by some that with the growth in volumes and giant strides in telecommunication, banks may no longer need to deal through brokers when efficient match making arrangements exist.
As in some other markets, the deals are concluded on the basis of voice broking and it is sometimes held that this often results in conclusion of deals which are less than transparent, evidenced by instances where deals have been called off on payment of differences. Under the circumstances, there is perhaps a need to review several aspects, viz. , compatibility of advising or prescribing fees with pro-competition policy; role of brokers; electronic dealing vis-à-vis voice broking; and relationship between the RBI, FEDAI and authorised dealers. Issues that Require Further Consideration First, there are some limits on freedom accorded to banks, such as ones on borrowing and investing overseas; ceilings on interest rates and maturities of non-resident foreign currency deposits; and these could be reviewed at appropriate time, with a view to liberalising them prudently.
* Second, the medium-term objective of reducing cash reserve requirements to the minimum prescribed in the statute and the longer term objective of proposing amendments to the statute to make all the reserve requirements flexible will be pursued, consistent with developments in fiscal and monetary conditions. Third, the restoration of freedom to corporates to hedge anticipated exposures is continuously under review. However, the issue of restoration of facility to rebook cancelled contracts needs to be reviewed with caution. * Fourth, the extension of facility of forward cover to FIIs is also under continuous review, though facilities available now are yet to be fully utilised by FIIs. * Fifth, trading in derivatives is a desirable objective, but a number of preconditions are to be satisfied in the matter of institutional as well as regulatory arrangements.
This is a complex task, but certainly is on the agenda of reform. * Sixth, setting up a forex clearing house is on the agenda and it is essential to design it on par with other leading clearing systems in the world. * Seventh, a number of recommendations of Tarapore Committee have been accepted, and others are also reviewed from time to time. A view will have to be taken on each one of them only in the context of overall liberalisation of capital account, which in turn, depends on, among other things, progress of our financial sector reforms and evolving international financial architecture. Eighth, development of deep and liquid money market with a well-defined yield curve in place is an accepted objective of RBI.
The actions taken and those contemplated to perform this hard task have already been articulated in my earlier speeches on money and debt markets, and the recent Monetary and Credit Policy Statement of April 1999 has provided evidence of RBI’s approach in this regard. * Ninth, implementation of the recommendations of the Report on Public Sector Enterprises will facilitate the efficient management of their foreign currency risks and also even out lumpy demand and supply situations in the forex market. Tenth, while there is a dominant view that setting up Mumbai as an off-shore financial centre is no longer a necessity, the views of CII, which is posing the issue, may have to be awaited and considered seriously.
* Eleventh, in any effort to develop markets, role of self regulatory bodies is critical. The role of FEDAI in achieving greater competition, efficiency and transparency in the forex markets needs to be reviewed on a continuous basis, so as to keep pace with developments in technology and financial sector reforms. Twelfth, a number of legislative changes are under contemplation, and of these the ones relating to Foreign Exchange Management and Money Laundering are critical to development of forex markets. Harmonisation between existing institutions, regulations and practices, including transition path to new legislative framework would be a significant task in the context of forex market development. * Thirteenth, several representations have been received by Regulations Review Authority to simplify, streamline and rationalise some of the regulatory and reporting requirements pertinent to foreign exchange.
The RRA should be taking a final view in the matter, on the basis of expected report of group of Amicus Curiae, within a few weeks. * Fourteenth, in the area of technology, on-line connectivity has been initiated in respect of data transmission by market to the RBI. Once this system is fully established, it will lead to a very prompt and effective on-line monitoring by RBI as well as reduction in multiplicity of reporting statements.
Similarly, initiatives are underway to expedite back office linkage between banks themselves and with RBI for settlement, which will fructify once the VSAT is fully operation Conclusion To conclude, the medium-term objective of developing an efficient and vibrant forex market continues to be an important priority within the overall framework of development of financial markets. Naturally, the pace and sequencing have to be determined by both the domestic and international developments.
In particular, the unique features of Indian forex markets, legal, institutional and technological factors, and developments related to macro-economic policies would govern the path of moving towards the medium-term objective, without sacrificing freedom in tactical measures to respond to unforeseen circumstances in the very short-term. Global market in convertible currencies are traded and their conversion rates are determined. It is the world’s largest financial market in which every day, on average, some one and one-half trillion dollar worth of currencies are bought and sold.
Out of this only about 15 percent is traded for goods or services, the balance 85 percent is traded by the individual and institutional speculators. (1) Market Structure: Current organization of the largest spot currency markets is driven primarily by the management of credit risk, as opposed to drivers identified in microstructure theory (such as management of market risk, attenuation of asymmetric information, and entry barriers). (2) Information Structure: Price variation in spot currency markets is drivenprimarily by dispersed information, as opposed to the orthodox assumption of public information.
