Unit 4

Foreign Exchange Market

BASIC CONCEPTS/TERMINOLOGIES
Foreign Currency vs. Foreign Exchange
As per Foreign Exchange Act, (Section 2), 1947.
•(c) "Foreign Currency" means any currency other than
Indian currency;
•(d) "Foreign Exchange" means includes any instrument
drawn, accepted, made or issued under clause (8) of section
17 of the Banking Regulation Act, 1956, all deposits, credits
and balance payable in any foreign currency, and any drafts,
traveler’s cheques, letters of credit and bills of exchange,
expressed or drawn in Indian currency but payable in any
foreign currency;
 What is an Exchange Rate ?
Exchange Rate is the price of one country's currency
expressed in another country's currency. In other
words, the rate at which one currency can be
exchanged for another.

Major currencies of the World

USD
EURO
YEN
POUND STERLING
US Dollar 64.525005

Euro 68.685612

British Pound 81.068901

Australian Dollar 48.763588

Canadian Dollar 48.420859

Singapore Dollar 46.130723

Swiss Franc 64.279588

Malaysian Ringgit 14.637004

Japanese Yen 0.591765

Chinese Yuan Renminbi 9.378927

Kuwaiti Dinar 211.807108

Exchange rate arrangements

•Exchange rate is no of units of one currency needed to acquire

one unit of another currency
•IMF was organized to promote exchange-rate stability & facilitate
int. flow of currencies.
•Bretton Woods Agreement established a system of fixed exchange
rates where each member country set a par value or benchmark
value for its currency based on gold & the US dollar.
• Because Dollar value was fixed at $35 per ounce of gold; the
exchange of a particular currency for gold or dollar had the same
implication.
Determination of exchange rate

The exchange rate regimes as described earlier could be

either fixed or floating; with fixed rates varying in
terms of how fixed they are & floating rates varying in
terms of how much they actually float.
• Fixed exchange rate system
• Floating exchange rate system
Exchange rates change in different ways depending on
whether they are floating rate of fixed rate regimes.
• Floating rate regimes
Currencies that float freely respond to supply & demand
conditions free from govt intervention
Demand for a country’s currency is a function of the
demand for that country’s goods & services & financial
assets such as securities.
The supply of a country’s currency is a function of that
country’s demand for the goods & services & financial
assets of some other country.
The equilibrium exchange rate –decided at the
intersection of the two market forces.
As the market forces change, exchange rate will also
move to new equilibrium level.
For e.g. let us assume demand for US goods & services by
Japan drops because of inflation in US.
This reduced demand would result in a reduced supply of
yen in the forex market
Simultaneously, increasing prices of US goods –lead to an
increase in demand for Japanese goods by US consumers
This, in turn, lead to an increase in demand for yen in the
market
From dollar’s point of view, increased demand for japanese
goods lead to an increase in supply of dollar as more
consumers in US try to trade their dollar for yen.
Reduced demand for US goods results in a drop in demand
for dollars
This pushes the exchange rate to new equilibrium level
making yen more costly against dollar or reduces dollar
value against yen.
Thus high inflation in one country compared to another
raises the demand for currency of another country
increasing value of that another currency against
domestic currency.
• Managed fixed rate regime
There can be times when one or both countries might not
want exchange rate to change.
In a managed fixed exchange rate system, the central
bank of one country, holds foreign-exchange reserve,
which it would have built up over the years to face
contingencies.
 Theories of Exchange Rate
Determination

• Purchasing Power Parity (PPP) Theory

• Interest Rate Theory
• Balance of Payment Theory
Purchasing power parity (PPP)

A well known theory that seeks to define relationship

between currencies.
When exchange rates are free to fluctuate, rate of exchange
between 2 currencies in the long run determined by their
purchasing powers.
Acc to Cassel “the rate of exchange between 2 currencies
must stand essentially on the quotient of the internal
purchasing powers of these currencies”.
Thus, acc to PPP the exchange rate between 2 currencies is
in equilibrium when their domestic purchasing powers at
that rate of exchange are equivalent.
 for e.g. 1 k.g. rice in India costs Rs 50 & in US $1.
The exchange rate between $ & Rs would be at
equilibrium if $1 =Rs 50.
A change in purchasing power of currencies will be
reflected by change in their exchange rate.
Claims that a change in relative inflation between 2
countries (comparison of two country’s inflation rates)
causes a change in exchange rate to keep price of
goods in 2 countries fairly similar
For e.g. Japan’s inflation rate is 2%; for US 3.5%, the
dollar value expected to fall due to difference in
inflation rates.
On the other hand, if the domestic inflation rate is lower
than that in the foreign country, the domestic currency
should be stronger than that of foreign currency
However, PPP theory is subject to following criticisms –
• Quality of goods & services may vary from country to
country; hence comparison of price without regard to
quality is unrealistic.
• Ignores cost of transportation in int. trade.
• Ignores the impact of int. capital movement on foreign
exchange market.
In reality, such movement might cause changes in
exchange rate.
For e.g. When there is capital inflow from US into India,
demand for rupee & supply of dollar increase & this, in
turn, results in appreciation in value of rupee &
depreciation in the value of dollar.
• The theory ignores the impact of changes in exchange
rate on prices.
For e.g. as a result of rupee appreciation, Indian exports
may decline, supply of goods in domestic market in
India increases causing fall in price in domestic market.
• Theory doesn’t explain anything about demand for or
supply of foreign exchange.
When exchange rate is determined by these 2 market
forces, any theory that doesn’t pay adequate attention
to these factors prove to be unsatisfactory.
• The theory starts with a given rate of exchange; but
fails to explain how that rate is arrived at.
Thus, it only tells how the exchange rate will change
based on changes in purchasing power of 2 currencies.
• Theory assumes elasticity of demand for exports &
imports is equal to unity; i.e. theory holds good, only if
exports & imports change in the same proportion;
most of the times it doesn’t hold true.
• No satisfactory explanations regarding short-term
changes in exchange rate.
• Theory makes use of price index no. to measure
changes in equilibrium rate of exchange; hence suffers
from various limitations of price index number.
• Another unrealistic assumption of theory is that int.
trade is free from all barriers.
• Finally, the theory goes contrary to general experience.
There has hardly been any case where the exchange rate
between two currencies has been equivalent to the
ratio of their purchasing powers.
Despite its limitations, PPP theory, exposes some very
imp. aspects of exchange rate determination.
• Indicates the relationship between internal price level
& exchange rates.
• Explains the state of trade of a country & the nature of
its balance of payments at a particular point of time.
Interest rate
Although inflation has the most imp. long-run influence
on exchange rates, interest rates are also important.
Interest rate, net of inflation rate, would determine how
attractive an economy is for investment purpose & that
will, in turn, decide the demand for that currency in
the foreign exchange market.
Balance of payment (BOP) theory
BOP theory, also known as demand & supply theory or general
equilibrium theory of exchange rate holds that exchange rate
under free market conditions is determined by demand &
supply in forex market.
Price (exchange rate) of a currency is determined just like the
price of any commodity.
Extent of demand & supply of country’s currency depends on
country’s BOP position.
If BOP is in equilibrium, demand for & supply of that currency are
equal.
When there is deficit in BOP, supply of currency exceeds demand
for it; results in a fall in external value of the currency;
When BOP is surplus; demand for currency exceeds supply of it;
resulting in rise in external value of the currency.
Other factors
Various other factors also cause exchange-rate changes
One imp factor among them is confidence level
In times of turmoil (confusion), people prefer to hold
currency which they consider safe.
Exchange rates may also be influenced by technical
factors as the release of national economic statistics,
seasonal demand for currency (tourism industry) etc.
 Foreign Exchange
• Also known as FOREX, FE, or FOEX.
• The importing country pays money to the exporting country
in return of goods in the domestic currency. This currency
which facilitates the payment to complete the transaction is
called “foreign Exchange”.
• According to “Dr. Paul Einzig”, “ Foreign Exchange is the
system or process of converting one national currency into
another and of transferring money from one country to
another.
• The term foreign exchange is used to refer to foreign
currencies.
• Foreign exchange includes foreign currency, foreign
cheques, and foreign drafts.
Foreign Exchange Market:
• Foreign exchange market is the market for sale and
purchase of different currencies.
• The market for foreign exchange is the largest market in the
world.
• The market operates almost 24 hours a day so that there is a
market open where you can trade foreign exchange.
• It is also a “Credit Market”.
• The goods and services cannot move between countries
without foreign exchange markets.
• Foreign exchange in recent times is traded through online.
• The most important confidence or participants in the market
are banks.
• Foreign exchange market is the market for currencies of
various countries anywhere in the globe, as the financial
centre's of the world are united as a single market.
Nature of Foreign Exchange Market:
• Widespread Geographically:
Foreign exchange transactions take place in all the
countries in the world and in all geographical areas in each
country.
• All time operations:
Foreign exchange market carries transactions 24 hours a
day and 365 days a year.
• Market Participants:
Foreign exchange market consists of two levels, namely,
interbank or wholesale market.
The participants in the foreign exchange market include: Bank
and Non – Bank foreign exchange dealers, individuals and
firms conducting commercial and investment transactions,
speculators and arbitragers, Central banks and Foreign
exchange brokers.
Banks and Non – Bank foreign exchange dealers operate in
interbank and client markets. They buy foreign exchange at a
“bid” price and sell at a higher price called “Ask” price and
thus make a profit.
Speculators and arbitragers participate in foreign exchange
market to earn profit by trading in foreign exchange rates.
Arbitragers try to earn profit from exchange rate differences in
different markets.
Central banks participate in the market to acquire and spend
foreign exchange reserves and to influence the price in the
market.
Foreign exchange brokers trade in foreign exchange on
behalf of their principals, by charging a small commission for
their service.
• Size of the Market:
The volume of foreign exchange traded in the foreign
exchange market is very large.
Features:
• The foreign exchange market performs international
clearing function by bringing two parties wishing to trade
currencies at agreeable exchange rates.
• There are importers or exporters of goods, services and
financial assets who are participants.
• The foreign exchange market operates 24 hours a day
permitting intervention in the major international foreign
exchange markets at any point in time.
• Until recently, this market was used mostly by banks., who
fully appreciated the excellent opportunities to increase their
profits. Today, it is accessible to any investor enabling him to
diversify his portfolio.
 Quick Review of Market Characteristics
• World’s largest financial market.
– Estimated at $3.2 trillion dollars per day in trades.
• NYSE-Euronext currently running about $40 billion per day.
• Market is a 24/7 over-the-counter market.
– There is no central trading location.
– Trades take place through a network of computer and telephone
connections all over the world.
• Major trading center is London, England.
– 34% of all trades take place through London (New York second at
17%).
• Most popular traded currency is the U.S. dollar.
– Accounts for 86% of all trades (euro second at 27%).
• Most popular traded currency pair is the U.S. dollar/Euro.
– Represents 27% of all trades (dollar yen second at 13%)
• Currencies are either traded for immediate delivery (spot) or
some specified future delivery (forward).
Functions of Foreign Exchange Market:
• Transfer of Purchasing Power:
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.
• Provision of credit for International business:
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.
• Provision of Hedging facilities:
The other important function of the foreign exchange
market is to provide hedging facilities.
What is a Foreign Exchange Transaction ?
– Any financial transaction that involves more than one
currency is a foreign exchange transaction.
– Most important characteristic of a foreign exchange
transaction is that it involves Foreign Exchange Risk.
 PARTICIPANTS IN THE FOREIGN EXCHANGE
MARKET
• All Scheduled Commercial Banks
(Authorized Dealers only).
• Reserve Bank of India (RBI).
• Corporate Treasuries.
• Public Sector/Government.
• Inter Bank Brokerage Houses.
• Resident Indians
• Non Residents
• Exchange Companies
• Money Changers
Location
1. OTC-type: no specific
location
2. Most trades by phone,
telex, or SWIFT

SWIFT: Society for Worldwide Interbank Financial

Telecommunications
 ORGANIZATION OF THE FOREIGN EXCHANGE
MARKET

1. Spot Market:
• The term “Spot Exchange” refers to the class of foreign exchange
transactions which requires the immediate delivery or exchange of
currencies on the spot.
• The “Spot Exchange rate” refers to the current exchange rate.
- Immediate transaction
- Recorded by 2nd business day
Participants
a. Commercial banks
b. Brokers
c. Customers of commercial and central banks
 THE SPOT MARKET
Transactions Costs

Bid-Ask Spread used to calculate the fee

charged by the bank
Bid = the price at which the bank is willing to buy
Ask = the price it will sell the currency
 Bid and Ask Quotes
• The market maker always provides the market with
two prices, both a buy and sell quote (or price) for a
currency.
• For Example:
USD/INR=64.6550/64.6650
• The first quote is the bid(the price at which buy dollar
against rupee)
• The second quote is the ask or offer(the price at
which sell dollar against rupee)
• Difference between bid and ask is Spread.

• Note: The bid quote is always lower than the ask quote.
Observing Changes in Spot Exchange Rates

• Appreciation (or strengthening) of a currency:

– When the currency’s spot rate has increased in
value in terms of some other currency.
• Depreciation (or weakening) of a currency:
– When the currency’s spot rate has decreased in
value in terms of some other currency.
 ORGANIZATION OF THE FOREIGN EXCHANGE
MARKET
2. Forward Market
Forward transaction is an agreement between two parties requiring
the delivery at some specified future date of a specified amount.
The rate of exchange applicable to the forward contract is called the
“Forward Exchange Rate”.
• The “Foreign Exchange Rate” refers to an exchange rate
that is quoted and traded today but for delivery and payment
on a specific future date.
a. Arbitrageurs
b. Traders
c. Hedgers
d. Speculators
• With reference to its relationship with the spot rate, the
forward rate may be at par, discount or premium.
• At Par:
If the forward exchange rate quoted is exactly equivalent
to the spot rate at the time of making the contract the forward
rate is said to be at par.
• At Premium:
A foreign currency is said to be at a premium when its
forward rate is higher than the spot rate.
Forward Rate > Spot Rate, then forward rate of foreign
currency is at a Premium. The premium is usually expressed as
a percentage deviation from the spot rate on a per annum
basis.
• At Discount:
A foreign currency is said to be at a discount when its
Spot rate is higher than the forward rate.
Spot Rate > Forward Rate, then forward rate of foreign
currency is at a Discount.
• The forward exchange rate is determined mostly by the
demand for and supply of forward exchange.
• When the demand for forward exchange exceeds supply, the
forward rate will be quoted at a premium.
• When the supply of forward exchange exceeds the demand,
the rate will be quoted at discount.
• When supply is equivalent to the demand for forward
exchange, the forward rate will tend to be at par.
 Forward Rate Quotes
• As a rule, forward exchange rates are set at either
a premium or discount of their spot rates.
– If a currency’s forward rate is higher in value than its
spot rate, the currency being quoted at a forward
premium.
• For example: the Japanese 1 month forward is greater than its
spot (0.009034 versus 0.008999)
– If a currency’s forward rate is lower in value than its
spot rate, the currency is being quoted at a forward
discount.
• For example, the British pound 6 month forward is less than
its spot (2.0417 versus 2.056).
According to International Convention two rates are
quoted namely,
Direct quote/ rate (Home currency quotation)
Indirect quote/ rate (Foreign currency quotation)
• Quotes using a country’s home currency as the price
currency are known “Direct quotation or Price quotation”
and are used by most countries.
• Direct quote is one where foreign currency is base currency
(fixed), domestic currency varied against foreign currency.
• Quotes using a country’s home currency as the base
Currency are known as “Indirect quotation or Quantity
quotation” and are used in British newspapers and are also
common in Australia, New Zealand, and the Euro Zone.
 RATE QUOTATION CONVENTIONS
IN-DIRECT QUOTATION:
“Price of one Unit of Foreign Currency in terms of
Domestic Currency”
e.g. USD/INR = 64.50/60
Buy One USD at 64.50
Sell One USD at 64.60
Spread 00.10
In the international market, almost all currencies are
quoted indirectly.
 RATE QUOTATION CONVENTIONS
DIRECT QUOTATION:
“Price of one Unit of Domestic Currency in terms of Foreign Currency”
e.g. INR/USD 0.0155/0.0162
Buy One INR at 0.0155
Sell One INR at 0.0162
Spread 0.0007

Five Currencies are quoted in Direct Terms

1) Pound Sterling
2) Euro
3) Australian Dollar
4) New Zealand Dollar
5) Irish Punt
– Foreign exchange transactions are settled through Nostro and
Vostro accounts.

• Nostro: our account with banks abroad. Reserve Bank of

India (RBI) maintains various Nostro accounts in a number of
countries.
• Vostro: their account with us. Many multilateral agencies
(e.g. IMF, World Bank) maintain their Nostro accounts at
Reserve Bank of India (RBI).

– SWIFT (Society for Worldwide Interbank Financial

Telecommunications)
 Foreign Exchange Risk
Exposure to exchange rate movement.
1. Any sale or purchase of foreign currency
entails foreign exchange risk.
2. Foreign exchange transaction affects the net
asset or net liability position of the
buyer/seller.
3. Carrying net assets or net liability position in
any currency gives rise to exchange risk.
 ISO Currency Designations
• All foreign currencies are assigned an International Standards
Organization (ISO) abbreviation.
– E.g., USD; JPY; GBP; EUR; AUD; HKD; CNY; MXN; SGD; ARS;
THB; INR; RUB; ZAR; NZD; CHF; KRW
• Since the exchange rate is simply the ratio (i.e., value) of one currency
against another, market makers express this relationship using the two
currencies’ ISO designations.
• For Example:
– USD/JPY
– USD/MXN
– EUR/USD
– GBP/USD
– EUR/JPY (this is a cross rate; since USD in not one of them)
Foreign Exchange Markets

Role of Reserve Bank of

India (RBI) and linkages
with economy
 RBI’s Role in the Forex Market

• To manage the exchange rate mechanism.

• Regulate inter-bank forex transactions and monitor
the foreign exchange risk of the banks.
• Keep the exchange rate stable.
• Manage and maintain country's foreign exchange
reserves.
Exchange Rate of Indian Rupee:
• 1947- 1971: The Indian Rupee had a fixed exchange rate
under the par value system of IMF.
• Rupee was devalued twice in 1947 and 1966.
• In 1966, foreign aid was cut off and India was told it had to
liberalize its restrictions on trade before foreign aid would
again materialize.
• In 1971- 1975: The exchange rate of the rupee was pegged
to dollar via sterling in December 1971.
• 1975- 1992: The exchange rate of the rupee was pegged to a
basket of currencies with effect from September 1975.
• In 1991, India still had a fixed exchange rate system.
• India started having balance of payments problem since
1985, and by the end of 1990, it found itself in serious
economic trouble.
• As in 1966, India faced high Inflation and large government
budget deficits. This led to the government to devalue rupee.
• 1992- 1993: In March 1992, a dual exchange rate system
was introduced.
• Here 60% of the foreign exchange earnings could be
converted into rupee at the market rate and 40% at official rate
determined by the Reserve Bank (RBI).
• 1993 onwards – Flexible/ Floating/ Market determined
exchange rate system.
March 1993 a single floating exchange rate in the market of
foreign exchange in India was implemented.
• The exchange rate of Rupee is determined by the market
forces of demand and supply. If the currency is more valuable
then demand is more than the supply, and if the currency is
less valuable then demand is less than supply.
• There are occasional interventions of the RBI on the foreign
exchange market to prevent movements of the exchange
rate.
A few major events that changed the
currency rates.
• June 4, 1966. First major devaluation. For the first
two decades, India had almost a constant peg
against the dollar at Rs.4.75/$. Then things
changed in 1966. India had just fought 2 major
wars (with China and Pakistan) and have had 3
prime ministers in 3 years (Nehru, Shastri, Indira)
after 17 years of one man rule. Then a major
drought shook the country. Perfect storm. 1966
Budget With nowhere to go and no more dollars,
the Indian government announced a 57%
depreciation of the rupee overnight from
Rs.4.75/$ to Rs.7.5/$.
• 1980s inflation. From 1966 to 1980, rupee
stayed constant. However, the 1979 energy
crisis and gold's skyrocketing prices in early
1980s left India with no place to go (oil and
gold were historically our primary imports).
Indian rupee started to slowly decline. From
about 7.85/$ in 1980 we reached about 17/$
by 1991.
• 1991 crisis. In July 1991, another major crisis. Biggest
event in modern Indian economic history. Overnight
rupee was devalued by another 50% from about 17/$
to about 25/$.
• 1993 liberalization. In 1993, Indian finance minister
Manmohan Singh let rupee to float a little freely.
Translation: the rupee was allowed to be traded by
traders without a forced peg such as the one kept by
China. Rupee value started to slide as the government
was no longer controlling the prices, fully and started
to reflect the reality. From about 27/$ it slid to Rs.35/$
by 1997.
Foreign Exchange Market in India:
• Foreign Exchange Market in India operates under the
Central Government of India and executes, wide powers to
control transactions in Foreign Exchange.
• The Foreign Exchange Management Act, 1999 or FEMA
regulates the whole Foreign Exchange Market in India.
• To recommend the Public Accounts Committee, the Indian
Government passed the FERA in 1973. and gradually this act
became famous as FEMA.
• Before the introduction of this act, the foreign exchange
market in India was regulated by the Reserve Bank of India
through the Exchange Control Department, by the Foreign
Exchange Regulation Act or FERA, 1947.
• After, independence FERA was introduced as a temporary
measure to regulate the inflow of the foreign capital.
• With the economic and industrial development, the Indian
Government passed the Foreign Exchange Regulation act,
1973 and gradually this act became famous as FEMA.
• The Foreign Exchange Market in India is growing very
rapidly, since the annual turnover of the market is more than
$400 billion.
• The main center of Foreign Exchange in India is Mumbai.
• There are several other centers for foreign exchange
transactions in India including the major cities of Kolkata,
New Delhi, Chennai, Bangalore, Pondicherry and Cochin.
• Foreign Exchange Trade goes on between Authorized
Dealers and Reserve Bank of India or between the Authorized
Dealers and the Overseas Market.
• The IDBI and EXIM Bank are also permitted at specific
times to hold foreign currency.
 Currency Convertibility
• Currency convertibility refers to the freedom
to convert the domestic currency into other
internationally accepted currencies and vice
versa at market determined rates of exchange.

• Export-Import of goods.
• Pursuing Higher education abroad.
• Tourism.
 Types of Convertibility
• CURRENT ACCOUNT CONVERTIBILITY- allows
residents to make and receive trade related
payments. Example- import-export.

• CAPITAL ACCOUNT CONVERTIBILITY- means

the freedom to convert the local financial
assets into foreign assets.
 Current Account
Current account convertibility refers to freedom in
respect of Payments and transfers for current
international transactions.
Transactions relating to:
- Exchange of goods and services
- Money transfers
In other words, if Indians are allowed to buy only
foreign goods and services but restrictions remain on
the purchase of assets abroad, it is only current
account convertibility.
 Current Account
Transactions
• All imports and exports of merchandise.

• Invisible Exports and Imports (sale/purchase

of services)

• Inward private remittances (to & fro)

• Pension payments (to & fro)

• Government Grants (both ways)

 Capital account

• Inflows and Outflows of capital.

• Borrowing from or Lending to aboard.

• Sales and Purchase of securities aboard.

Capital Account Transactions

 Capital Direct Foreign Investments.

 Investment in securities.
 Other Investments.
 Government Loans.
 Short-term investments.
 Capital Account Transaction’s
Classification

Direct Other
Portfolio
Investment . Investment. investment

 Stocks,  Real estate Holdings in

 Bonds,  Production loans
 Bank facilities
 Loans,
 Bank
 Equity accounts
 Derivatives.
investment Currencies
.
 Capital Convertibility
• Non-Convertible capital
– Cuba(peso) and North Korea(won)
– Non participation in FOREX market
– Major challenge for domestic currencies there.
• Partial Convertible Capital-
– Indian Rupee
– RBI’s restriction on the inflow and outflow of capital
• Full Convertible Capital-
– US dollars
– No restrictions or limitation on the amount to be
traded
– Thus, this is one of the major currency traded in FOREX
market
 Non convertible Currency

Also known as a "blocked currency".

Any currency that is used primarily for domestic
transactions and is not openly traded on a forex
market. This usually is a result of government
restrictions, which prevent it from being
exchanged for foreign currencies
RUPEE CONVERTIBILITY
 Introduction

• The Indian rupee(Devanagari:

रुपया)) is the official currency of
“The republic of India”.

• Today, the currency is available

in the form of “Bank notes” and
“coins of the rupee”.
 History of Rupee Convertibility
• Upto 1991, there was rigid control on both
Capital and Current account.

• Capital account convertibility was introduced

in India in August 1994.

• In 1997 the Government had set up a

committee (Tarapore committee) to spell out
a road map for the full convertibility of the
rupee.
 Convertibility of Rupee
Convertibility of a currency implies that a currency can
be transferred into another currency without any
limitations or any control.
A currency is said to be fully convertible, if it can be
converted into some other currency at the market price
of that currency. Convertibility can be related as the
extent to which a country's regulations allow free flow
of money into and outside the country.
Convertibility of rupees is known as freedom of
exchange of rupee with other all international currency
 Current Account
Convertibility
 Indian scenario - fully convertible.

 Full freedom to both residents and non-

residents.
 RBI has placed a cap in creation of a capital
asset
 Freedom in respect of payments and transfers
for current international transactions.
 Tarapore Committee
• Committee on capital account credibility,
set up by RBI(Reserve Bank of India) under
the chairmanship of former RBI deputy
governor S.S. Tarapore.
• Economists Surjit S Bhalla, M G Bhide, R H
Patil, A V Rajwade and Ajit Ranade were
the members of the Committee.
• The report submitted by this Committee in
the year 1997 proposed a three-year time
period (1999-2000) for total conversion of
Rupee
 Tarapore Committee
• Reasons for the introduction of CAC in India:
 It was meant to ensure total financial mobility in the country
 It also aimed in the efficient appropriation or distribution of
international capital in India

• Pre - conditions:
 The fiscal deficit needs to be reduced to 3.5% of the GDP
 Inflation rates need to be controlled between 3-5%
 Non-performing assets (NPAs) need to be brought down to 5%
 Cash Reserve Ratio (CRR) needs to be reduced to 3%
 A monetary exchange rate band of plus minus 5% should be instituted
 The Second Tarapore Committee on
Capital Account Convertibility
• Reserve Bank of India appointed the second Tarapore
committee to set out the framework for fuller Capital
Account Convertibility.
• The committee was established to revisit the subject of fuller
capital account convertibility in the context of the progress in
economic reforms, the stability of the external and financial
sectors, accelerated growth and global integration.
• The report of this committee was made public by RBI on 1st
September 2006. In this report, the committee suggested 3
phases of adopting the full convertibility of rupee in capital
account.
 First Phase in 2006-7
 Second phase in 2007-09
 Third Phase by 2011.
 Recommendations
• Following were some important recommendations of this
committee:
 The ceiling for External Commercial Borrowings (ECB) should
be raised for automatic approval.
 NRI should be allowed to invest in capital markets
 NRI deposits should be given tax benefits.
 Improvement of the Banking regulation.
 FII (Foreign Institutional Investors) should be prohibited from
investing fresh money raised to participatory notes.
 Existing PN holders should be given an exit route to phase out
completely the PN notes.
 At present the rupee is fully convertible on the current
account, but only partially convertible on the capital account.
Benefits of capital account convertibility to India:
The Tarapore Committee mentioned the following benefits of capital
account convertibility to India:
1. Availability of large funds to supplement domestic resources and
thereby promote economic growth.
2. Improved access to international financial markets and reduction
in cost of capital.
3. Incentive for Indians to acquire and hold international securities
and assets, and
4. Improvement of the financial system in the context of global
competition.
5. Freedom to convert local financial assets into foreign ones at
market-determined exchange rates
6. Leads to free exchange of currency at lower rates and an
unrestricted mobility of capital
The USDINR increased 0.0200 or 0.03% to 64.6300 on Friday
April 21 from 64.6100 in the previous trading session.
Historically, the Indian Rupee reached an all time high of 68.80
in February of 2016 and a record low of 7.19 in March of 1973.
FROM TRADE TO CAPITAL MOBILITY
Trade

Traders need to hold

or borrow foreign Better access to
exchange; trade
imbalances need to credit spurs trade
be financed

International finance

Range of Domestic
Domestic financial Access to institutions demand
financial firms products foreign relief form rules;
are forced to expands capital regulation ever
compete markets harder to enforce

Innovation Deregulation
 Capital Flows

Capital flows refer to the movement of money for the

purpose of investment, trade or business production,
including the flow of capital within corporations in the form
of investment capital, capital spending on operations and
research and development (R&D). On a larger scale, a
Government directs capital flows from tax receipts into
programs and operations and through trade with other
nations and currencies. Individual investors direct savings
and investment capital into securities, such as stocks, bonds
and mutual funds.
 Components of Foreign Capital in India

Foreign capital refers to the capital flows from

resident entity of one country to the resident
entity of another country. The resident entity
may be an individual, corporate firm or a
Government. In India, there are three
important components of foreign capital flows
1) Foreign Capital Investments
2) Foreign Aid
3) External Commercial Borrowings
1. Foreign Capital Investments:
Foreign capital investments refer to
investments made by an entity which is not
the resident of the country. In India there are
two components of foreign capital
Investments.
Foreign Direct Investments (FDI)
Foreign Portfolio Investments (FPI)
 Foreign Direct Investments (FDI)
• FDI refers to the physical investments made by foreign investors in the
domestic country. The physical investments refer to the direct investments
into building, machinery and equipments.

• Reserve bank of India (RBI) defines FDI as a process whereby resident of

one country (i.e. home country) acquires ownership for the purpose of
controlling production, distribution and other activities of a firm in
the another country.(i.e. the host country).

• It reflects the lasting interest by the foreign direct investors in the entity or
enterprise of domestic economy.

• There exists a long-term relationship between the foreign investor and the
domestic enterprise. The foreign direct investors generally exert a high
degree of influence on the management of the entity. The direct investor
can be an individual, public or private enterprises (referred to multinational
corporations or MNCs)) or Government.
• In India there are three important element of FDI:
a. Equity investments by foreign investors
b. Reinvested earnings i.e. retained earning of FDI
companies
c. Debt Investment (particularly the inter-corporate
debt between related entities).
• The important forms of FDI are investments
through:
(i) Financial Collaboration
(ii) Joint Ventures and Technical Collaboration
(iii) Capital Markets
(iv) Private Placements.
 Foreign Portfolio Investments (FPI)
• FPI refers to the short-term investments by foreign entity in
the financial markets.
• These are indirect investments and include investment in
tradable securities, such as shares, bonds, debenture of the
companies.
• Foreign Portfolio investors don’t exert management control on
the enterprise in which they invest.
• The important objective of FPI is the appreciation of the
capital investment regardless of any long-term relationship
with enterprise (IMF, Balance of Payment Manual).
• These investments are made with short-term speculative gains.
 There are three kinds of FPI in India
a) Foreign Institutional Investment: These are the
investments made by foreign institutions like pension
funds, foreign mutual funds etc. in the financial
markets.
b) Funds raised through Global Depository
Receipts or American Depository Receipts
(GDRs/ADRs): GDRs and ADRs are instruments
which signify the purchase of share of Indian
companies by foreign investors or American investors
respectively.
c) Off-shore funds: The schemes of mutual funds
that are launched in the foreign country.
 2. External Aid
• External aid refers to the concessional foreign finance with flexible terms and
conditions. It may be in the form of long term concessional debt or grants
(doesn’t involves any repayment obligations). The tenure of the aid is generally
very long.
• The important sources of foreign aid in India are:
(i) Official Aid:
It is given by foreign governments or international official bodies such World Bank,
International Monetary Fund (IMF), Asian Development Bank (ADB) etc. It can
be:
(a)Bilateral Aid: Loans or grants under bilateral (i.e. between two countries)
agreement.
(b)Multilateral Aid: loans or grants extended by multilateral (i.e. more than two
countries) agencies e.g. Loans from IMF, World Bank etc.

(ii) Private Aid: It is the fund which is received from private individuals, firms or
institutions.
 3. External Commercial
Borrowings (ECBs)
• ECBs comprises of borrowings from international
capital market on commercial terms.
• It covers all medium/long term loans e.g. supplier’s
credit, foreign currency convertible bonds (FCCBs),
e.g. India development bonds, resurgent India bond
(RIBs) etc. The interest rates on these borrowings are
higher than foreign aid.
• The higher dependence on these borrowings can
cause financial burden on the economy.
 Need of Foreign Capital
(1) Supplement domestic resources
(2) Improve Balance of Payment (BOP) Position
(3) Technological and Managerial Improvements
(4) Human Capital Improvements
(5) Creates Competitive and Efficient Business
Environment
(6) Augmentation of Employment Opportunities
(7) Improve Environmental and Social Conditions
(8) Better Corporate Practices
(10) Improvement in Financial System
 Limitations of Foreign Capital
• Crowds out local Capital and Entrepreneurial
Growth
• Adverse impact on BOP Position
• Distortions of Domestic Investment Patterns
• Competition for local Domestic Resources
• Outdated Technology
Investor perspective-What attracts FDI?

Market size-per-capita
income like retail telecom

FDI Resources-
Good capital/labour/infr
governance attractiveness astructure
Mining,gas,power

Efficiency -Productivity-wage
differentials
Mfg, trade, transport
India recorded a capital and financial account deficit of 19.06
USD Million in the fourth quarter of 2016. Capital Flows in India
averaged 13.39 USD Million from 2010 until 2016, reaching an
all time high of 766.96 USD Million in the second quarter of
2013 and a record low of -271.46 USD Million in the second
quarter of 2011.
Foreign Direct Investment in India increased by 874 USD Million in February of
2017. Foreign Direct Investment in India averaged 1225.67 USD Million from 1995
until 2017, reaching an all time high of 5670 USD Million in February of 2008 and a
record low of -60 USD Million in February of 2014.
Foreign Exchange Reserves in India increased to 369890 USD
Million on April 14 from 369000 USD Million in the previous
week. Foreign Exchange Reserves in India averaged 202451.48
USD Million from 1998 until 2017, reaching an all time high of
383643 USD Million in December of 2009 and a record low of
29048 USD Million in September of 1998.
India recorded a current account deficit of USD 7.9 billion or 1.4 percent of the GDP in
the last three months of 2016, higher than a USD 7.1 billion gap a year earlier. The
services surplus decreased to USD 17.6 billion (from USD 18 billion a year earlier),
mainly due to a fall in earnings from software, financial services and charges for
intellectual property rights.
Major Barriers to FDI inflows in India:
• Restrictive FDI regime
• Lack of clear cut and transparent sectoral policies for
FDI
• High tariff rates by international standards
• Lack of decision-making authority with the state
governments
• Limited scale of export processing zones
• No liberalization in exit barriers
• Stringent labour laws
• Financial sector reforms
• High corporate tax rates
GLOBAL PRICING STRATEGIES
 Introduction
Global pricing is one of the most critical and complex issues
that global firms face so it can give a break or a boost to
company’s revenue. It is important because:

• Price is the only marketing mix that generates revenue all other
entail costs.
• Local pricing v/s Global pricing
• Lack of the coordination in the global market will give rise to
gray market or parallel trade situation
• 4 C’s are the main drivers of global pricing strategies of any
company operating internationally: COMPANY, CUSTOMER,
COMPETITION and CHANNELS
 Company
Company includes the goals and costs as the major factor of
global pricing strategies.

Major Goals Include

• Growth Maximization/revenue maximization
• Market penetration
• Projection of an image

Companies objectives and goals are different in different

market. For example. New Balance, the US based shoe maker
sells its shoes in France as haute couture rather than athletic
shoes and they price it at almost double of the price in US.
 Costs
 Costs are different in different markets because of various reasons
like labor, raw material etc.
 Costs are very prominent in pricing decision of a firm because
pricing is done to cover the cost involved.
 Two costs are there
• Fixed costs
• Variable costs
 Export Pricing policies:
• Cost-Plus Pricing: adds international costs and a mark-up to the
domestic manufacturing cost.
• Dynamic Incremental Pricing: only variable costs and a portion of
the overhead load (incremental costs) should be recuperated.
Exporting-related incremental costs (manufacturing costs, shipping
expenses, insurance, and overseas promotional costs).
 Customer
If costs set the floor for pricing , consumer willingness to pay sets a
ceiling to the price. Consumer’s role in international pricing is
derived by these reasons:
• Buying power
• Taste
• Habits & Spending patterns
• Availability of substitutes

Option to tackle customers issue:

• Downsizing
• Niche player targeting upper end
• Portfolio of products
• Sell older version at low prices

Example: Proctor & Gamble downsized the packet size of Ariel in

Egypt thereby lowering the cash outlay for ordinary consumers.
 Competition
Competition plays an important role in pricing because we
have different kinds of competition in different market:

• Number of competitors:
 Monopoly, Perfect competition
• Nature of competition:
 Global or local players, state owned or private owned
• Position of company in the competition:
 Price leaders or price takers
• Knockoff items / counterfeit products:
 Imitation products offered for sale
• Smuggled goods.
 Channels
Distribution channels determine the pricing in different ways
depending upon:
• Length of channels:
producer to consumer in how many steps
• Balance of power between manufacturer and retailers
• Unauthorized distribution channels in the gray markets

For example:
US and Germany have direct marketers , supermarkets and
specialty retails for personal computers where as in Britain
prices are 50 % higher than in Germany with market
dominated by Dixons , a retail chain that charges high
margins.
 Govt. policies
Government policies can have a direct or indirect impact on the
pricing policies. Factors that have a direct impact are:
• Sales tax rates
• Tariffs
• Price controls
• Policy regarding Floor price/Ceiling price

Factors that have an indirect impact on pricing are:

• Interest rates
• Currency volatility
• Inflation
Factors Affecting International Pricing…

• Inflation
• Exchange Rate Fluctuations
• Parallel Imports
• Price Escalation
• Government Influences
 Concept of Price escalation
Exporting involves more steps and substantially higher risks
than domestic marketing.
• To cover the incremental costs (shipping, insurance, tariffs,
etc), the final foreign retail price will often be much higher
than the domestic retail price. This is known as price
escalation.

Price escalation raises two pressing issues:

• Sticker shock: willingness of foreign customers to pay the
inflated price
• Competitiveness: inflated price making the product less
competitive
Managing price escalation
• Rearrange the distribution channel: length of the channel, or
number of layers between manufacturer and end-user.
Example: US firms in Japan

• Eliminate costly features (or make them optional): core

product + optional feature available at extra cost

• Downsize the product

• Assemble or manufacture the product in foreign markets

• Adapt the product to escape tariffs or tax levies: Range Rover

in US.
 Pricing in Inflationary Environments
There are several alternative ways to safeguard against inflation
• Modify components, ingredients, parts and/or – packaging
materials
• Source materials from low-cost suppliers
• Shorten credit terms
• Include escalator clauses in long-term contracts
• Quote Prices in a stable currency
• Pursue rapid inventory turnovers
• Draw lessons from other countries
 Global Pricing and Currency Movements
Given the sometimes dramatic exchange rate movements, setting
prices in a floating exchange rate world poses a tremendous
challenge.
Two major managerial pricing issues result from currency
movements:
How much of an exchange rate gain (loss) should be passed
through our customers?
• Ex: Customer’s price sensitivity, the amount of competition in
the export market
In what currency should we quote our prices?
• Depends on the balance of power between the supplier and the
customer
• Some companies adopt a single currency
 Transfer pricing
It refers to the setting, analysis, documentation, and adjustment
of charges made between related parties for good, services, or
use of property (including intangible property).
Following criteria should be considered while making transfer
pricing decisions:
• Tax regimes
• Local Market conditions
• Market Imperfections
• Joint-venture partner
• Morale of local country managers
 Anti dumping regulation
 Dumping: imports are being sold at an “unfair”price

 Protectionism

To minimize risk exposure to antidumping actions, exporters

might pursue any of these strategies:
• Trading-up (move away from low-value to high-value
products)
• Service Enhancement: differentiate your product by adding
support services to the core product
• Distribution and Communication: strategic alliances
• Set up units in foreign country
 Countertrade
Countertrade is an umbrella term used to describe unconventional
trade-financing transactions that involve some form of noncash
compensation.

Types:
• Barter: Exchange of goods or services
• Switch trading: Practice in which one company sells to another its
obligation to make a purchase in a given country
• Counter purchase: Sale of goods and services to a country by a
company that promises to make a future purchase of a specific
product from the country
• Buyback: occurs when a firm builds a plant in a country - or
supplies technology, equipment, training, or other services to the
country and agrees to take a certain percentage of the plant's output
as partial payment for the contract
• Offset: Agreement that a company will offset a hard - currency
purchase of an unspecified product from that nation in the future
 CASE 1: McDonald’s Pricing Strategy in India

McDonald's India is a joint-venture company managed by Indians.

McDonald’s India, a subsidiary of McDonald’s USA, has expanded
its presence in India via 2 joint venture companies – Connaught
Plaza restaurants and Hard castle restaurants.
• McDonald's opened its doors in India in Vasant Vihar, New Delhi
in October 1996

Global Strategy:
• Customer driven, goal oriented
• Achieving sustainable, profitable growth
• Designed to increase restaurant visits and grow
• Brand loyalty among new & existing customers
• Further build financial strength
• A very popular punch line of Mcdonalds-“Aap ke zamane
mein, baap ke zamane ka daam”.
• The main reason of this price strategy was to attract the middle
class & the lower class of people in India. After this not only
the upper class prefers going there but all class of people go
there.

Value Pricing:
• Happy meal – small burger ,fries ,coke + toy
• Medium Meal Combo- burger ,fries, coke-veg Rs:75
,Maharaja Mac Meal Rs: 95
• Family Dines under Rs: 300
• Price lower than Pak ,Srilanka ,50% lower than U.S.
 Anti-globalization
• The political attitude of people and
organizations that resist certain aspects of
globalization.
• social movements
• participants are united in opposition to the
political power of large corporations
• Self-consciously internationalist, organizing
globally an advocating for the cause of
oppressed people around the world
 Anti-globalization Movements
• J18
– June 18, 1999
– London, UK; Eugene, Oregon

• Seattle/N30
– November 30, 1999
– 5,000 protesters blocked delegates’ entrance to WTO meetings in
Seattle
– Protesters forced the cancellation of the opening ceremony and lasted
the length of the meeting until December 3

• Genoa
– July 18 – July 20, 2001
– Biggest anti-globalization gathering in
history, 250,000 protesters against the G8
meeting in Genoa, Italy
– 3 dead, hundreds hospitalized
 Causes of Anti-globalization Movement

• Globalization globalizes money and

corporations, but not people and unions
• Outsourcing and offshoring caused millions of
westerns lost jobs or paid less
• Fear losing jobs in western countries
• Exploitation of the resources in the developing
countries by western countries
 Why anti-globalization?
• Economical
– Exploitation of the resources in the third world
country
– Example of Starbucks Vs. Ethiopian Coffee
• Ethiopians demand Starbuck’s support to trademark 3
of its coffees in US
• $4, a cup of Cappuccino at Starbucks;
• $.50, a day income
of the Ethiopian farmer
at the coffee farm
 Why anti-globalization?
• Cultural
– Local or minority culture are facing the fate of
disappearing
– Western culture invaded into developing countries
– Example: McDonalds
• More than 100 countries
• 30,000 restaurants
• Serves 50 million people daily
 Why anti-globalization?
• Environmental
– Aggravated pollution, Global warming, losses in biodiversity and
species extinction
– Average global temperatures are estimated to rise 1- 3.5
centigrade (33.8 – 38.5 degrees) by 2050
– Developed industrial countries export hazardous waste to third
world countries
– Example: one global
agribusiness firm closed a terminal
in Brazil's Amazon region for
environmentalists
 Why anti-globalization?
• Women and children
– 90% of the workers at the
sweatshops are women
– Child labor hired by global
companies in developing countries
• Example: 14-year-old workers in Nike factories in
Indonesia
 Why anti-globalization?
• Human rights
– More and more strict immigration restrictions in
developed countries, no free move for labors
– In sweatshops in developing countries, harsh working
conditions, low pay and overtime working are common
– Example: The Pouty Bratz dolls factory in Southern China
• Working 94 hours a week
• 17 cents, workers are paid for making each doll;
$19, retail price in US
• More than 120 million Bratz dolls sold in US since 2001
 Why anti-globalization?
• Social
– The unequal wealth distribution worldwide
– The gap between the developed countries and the
third world counties
– The gap between
the poor and rich
 Globalization might be harmful to
Developed Countries in the future
• China is striving to create global automobile
and electronics brands.
• India’s skill-intensive service sectors like IT and
outsourcing are rising very fast.
• Western firms would face unprecedented
competition from the two and other
developing countries.
 Conclusions
• Anti-globalization movements are the
indication of self-protection.
• Globalization already resulted in many
adverse effects and made a portion of people
worse-off.
• Globalization makes highly liberalized
countries expose their vulnerabilities to the
rest of the world.
 Association of Serbian Banks -ASB
• Formed in 1921 (The Association of
Banks was established by the 39
monetary institutes)
• Association of Serbian Banks strives
to build a position for and strengthen
the reputation of the Serbian banking
sector both locally and abroad.
• The founding session of the
Association’s Assembly was held on
December 4th 1921, in Prometna
Banka in Belgrade
 Pillars of the Association’s activities:

• Credit-monetary policy and banking supervision;

• Financial markets;
• Foreign economic relations;
• Retail operations;
• Legal operations;
• Accounting, internal auditing and taxation;
• Information technologies and standardization;
• Payment system and electronic banking;
• Marketing, publishing and PR activities.
Within the ASB, the following separate
organizational units were formed:
• Bank Training Centre
• Credit Bureau
• Interbank Clearing
• The members of the Association of Serbian Banks are
all banks operating in Serbia.
• The ASB is a member of the
– European Banking Federation (EBF),
– European Bank Training Network (EBTN),
– International Coordinating Council of Banking
Associations in CIS, Central and Eastern Europe
(International Banking Council –IBC),
– InterBalkan Forum of Bank Associations, and Commission
on Banking Technology and Practice of the International
Chamber of Commerce (ICC).
The ASB has an intense cooperation with numerous foreign
institutions, banking associations, banks and the
International Chamber of Commerce.
COOPERATION AGREEMENT SIGNED BY THE IFC
AND THE ASSOCIATION OF SERBIAN BANKS
was underlined by Mr Thomas Lubeck, IFC
Regional Manager for Western Balkans and Dr Veroljub Dugalić, ASB Secretary
General
 Activities of ASB
• Providing expert assistance to its members with a view to enhancing and
promoting their operations;
• Representing the common interests of its members with the competent state
authorities, as well as other authorities and organizations;
• Initiating the adoption of laws and other regulations, providing opinions on drafts
and proposals of laws and other regulations;
• Standardizing the banking practice by means of rules and standards;
• Organizing professional employee training in the field of banking and finance, and
issuing appropriate certificates;
• Cherishing good business customs and business ethics, and determining the rules
of good business conduct of it members in their mutual relations and in their
relations with third parties;
• Collecting the data from its members and third parties according to the law, in
respect of indebtedness of their clients – individuals and legal entities, as well as
processing, storing and transferring those data to the authorized users, on which
basis they gain insight into the indebtedness of clients, potential debtors, and the
regularity of settling their liabilities;
• Publishing books, the magazine, brochures, manuals, and other specialized
publications, along with the similar periodical issues.