CONTENTS

1) COMPANY S PROFILE 2) FOREIGN EXCHANGE y Meaning & Definitions y Problems Of Foreign Exchange y Importance Of Foreign Exchange y Need For Foreign Exchange 3) FOREIGN EXCHANGE RATES y Meaning & Definitions y Types Of Foreign Exchange Rates 4) THEORIES OF EXCHANGE RATE DETERMINATION y Mint Par Theory y Purchasing Power Parity Theory y Balance Of Payment Theory / Demand & Supply Theory 5) FOREIGN EXCHANGE RATES FLUCTUATIONS y Causes Of Fluctuations y Limits Of Fluctuations y Effects Of Fluctuations y Methods Of Control 6) FOREIGN EXCHANGE CONTROL y Origin Or Evolution Of Exchange Control y Meaning & Definitions y Characterstics y Merits Of Exchange Control

y Demerits Of Exchange Control y Methods Of Exchange Control 7) EXCHANGE CONTROL IN INDIA y Origin y Objective Of Exchange Control In India y Features Of Exchange Control In India 8) FOREIGN EXCHANGE MARKET y Overview y Participants In Foreign Exchange Market 9) INTERNATIONAL PAYMENTS y Meaning & Characterstics y Methods Of International Payments 10) FINANCIAL INSTITUTIONS y Authorised Dealers y Foreign Exchange Dealers Association Of India y Reserve Bank Of India y EXIM Bank y Export Credit Guarantee Corporation

2. FOREIGN EXCHANGE
In today s world economy, the existence of separate monetary unites under different monetary system poses a great problem, in the settlement of international transactions. Each party will like to get the payments in the currency of his own country. This complex situation makes the conversion of different world currencies compulsory. Foreign exchange is the mechanism by which the currency of one country gets converted into the currency of another. International trade and money and capital movements resulting from financial transactions are the basis of foreign dealings. Clearly the day that sees the arrival of a single world currency will also witness the disappearance of foreign exchange business.

MEANING OF FOREIGN EXCHANGE

The term Foreign Exchange is used in three different senses: i. In the sense of foreign currency or foreign bills Some economists use the term Foreign Exchange in a narrow sense. According to them, foreign exchange refers to sale and purchases of foreign currencies like US $(dollar) British Pound or Sterling and Japanese Yen. In the sense of Rate of Exchange According to this sense, foreign exchange refers the rate of exchange or the rate at which the currency of one country is converted into the currency of another country. In other words, the external value of domestic currency is the rate of exchange. In the sense of an Entire System of International Money Changing According to this wider sense, the term Foreign Exchange refers to that entire operational system by which the countries clear off their international obligations. It is a science and art of international money changing. It includes: a. All those institutions which facilitate international payments.

ii.

iii.

b. All methods and instruments used for making international payment. c. The rate at which the currency of one country is converted into the currency of another country.

DEFINITIONS
S.E.Thomas, Foreign Exchange is that branch of science of economics in which we seek to determine the principles on which the peoples of the world settle their debts one to the other. Hartley Withers, Foreign Exchange is a mechanism by which international indebtedness is settled between one country and another. It is an art and science of international money changing. Paul Einzig, Foreign Exchange (in singular) as a system or process of converting one national currency into another and transferring money from one country to another. Foreign Exchanges (in plural) as the mean of payment in which currencies are converted, international transfers are made, also the activity of transacting business in such means. FERA/ FEMA defines the term Foreign Exchange means foreign currency and includes1. All deposits, credits and balances payable in any foreign currency and any drafts, traveler cheques, letters of credit and bills of exchange, expressed or drawn in Indian currency but payable in any foreign currency. 2. Any instrument payable at the option of the drawer or holder thereof or any other party thereto, either in Indian currency or in foreign currency or partly in one and partly in the other. Thus, foreign exchange includes foreign currencies, balances kept abroad and instruments payable in foreign currency with the help of which countries of the world clear off their international obligations.

PROBLEMS OF FOREIGN EXCHANGES

In world economy, we know that every country has its own monetary system and separate monetary unit. For making international payment, the currency of one country has to be converted into the currency of another country. The problem of foreign exchange was not so complicated under the gold standard as it is today under the managed and regulated paper currency standard. The reason was that under gold standard, the payments were executed in terms of gold but it is not possible under present system. Due to this problem and in order to make international payment, the study of foreign exchange has become highly significant. 1. Existence of Different Currencies With Different Values In today s world economy, each country is having its own monetary system and monetary units and all the currencies of the world have different values. 2. Disequilibrium in Demand and Supply of Currencies All the currencies of the world are not equally demanded. They have imbalances in their demand and supply. Some currencies have more demand in comparison to the supply and vice versa. Some currencies having more demand in international market are called Hard or Dear currency while the currencies having more supply in comparison to their demand are called Soft Currencies 3. Lack of Stability in Exchange rates The foreign exchange rates also fluctuates frequently due to several reasons. Due to lack of stability in their rates also there are many problems. 4. Problem of the methods of International Payments- There is no generally accepted means and there are several problems in accepting payments in soft currency. Due to these problems, the international payments become more complicated. 5. Problem of Transfer of Payments- There are several problems in transferring payments because of so many hurdles and barriers imposed nu the countries under exchange control.

6. Problems of Determination of Rate of Exchange- How to determine the rate of exchange for one country s currency with the other currency of another country? There is no unanimity on this problem. 7. Problems of Restrictions imposed by Countries- Many measures of control restrictions are being imposed by almost all the countries of the world and create several types of problems.

IMPORTANCE OF FOREIGN EXCHANGES

In today s world economy, despite several problems of foreign exchange the volume of international economic and monetary transactions has tremendously increased and all countries of the world have been so integrated with each other that not a single country of the world could claim to be a self reliant economy . Its increasing importance can be explained as under: 1. For solving the Problems- For solving problems of foreign exchange enumerated above, the study of foreign had become vitally important. 2. Vital Role in International Trade- The foreign exchange plays a vital role in making international trade possible. Through the help of foreign exchange, a country can import essential goods, raw materials, machinery and other capital goods etc and export its surplus goods and earn foreign exchange. 3. Trade in Services With the help of foreign exchange, a country could render services in different fields like travels, transportation, communication, banking insurance and other can get services from other parts of the world. 4. Transfer of Technology- Foreign exchange also facilitates easy transfer of technology from one country to another. 5. Global Capital Movement- Capital is flowing throughout the world and it is due to foreign exchange. 6. International Remittance and Payments- from various parties like businessmen, tourists, NRIs and others huge amount is remitted and all these transactions have become possible with the help of foreign exchange. 7. It Facilitates Convertibility of All Currencies- Convertibility of currencies of the world has become easier under foreign exchange.

8. Development of a Separate Branch in Economics Science- Due to increasing importance, the foreign exchange has been developed as a distinct and important branch of economics science which deals in settling international obligations. 9. To Know the Complex Mechanism of International Payment- The foreign exchange has become more essential in the present complex and complicates system of international payment. So, in order to study that mechanism it has gained much significance. 10. Developed as a Powerful Market- Foreign exchange market has become the most powerful market among all international markets. The average daily foreign exchange dealings have exceeded $1 trillion which is very high in comparison to the volume of transactions in other international financial markets like security and capital market, Gold and Bullion markets. The growth of foreign exchange market had outpaced the output of goods and services in the world.

NEED FOR FOREIGN EXCHANGE

Where Indian company exports cotton fabrics to USA and invoices the goods in US dollar. The American importer will pay the amount in US dollar, as the same is his home currency.

Exports Cotton Fabrics Exporter Fabrics Importer

India n Co. US $

USA

However the Indian exporter requires rupees means his home currency for procuring raw materials and for payment to the labor charges etc. Thus he would need exchanging US dollar for rupee. If the Indian exporters invoice their goods in rupees, then importer in USA will get his dollar converted in rupee and pay the exporter.

Exports

$ convert Rs.

Indian Co. USA

Exporter is paid in Rs.

From the above example we can infer that in case goods are bought or sold outside the country, exchange of currency is necessary. Sometimes it also happens that the transactions between two countries will be settled in the currency of third country. In that case both the countries that are transacting will require converting their respective currencies in the currency of third country. For that also the foreign exchange is required.

3. FOREIGN EXCHANGE RATES

MEANING
Foreign Exchange Rate refers to the rate at which the currency of one country can be converted into the currency of another country. The rate of exchange, this, indicated the exchange ratio between the currencies of two countries, for example, if one US $ Dollar is equal to forty Indian Rupees. What this implies that one US $ can fetch forty rupees in the exchange market. Dealings in foreign exchange markets are carried out at specified rate or price of a unit of one currency in terms of another currency. It could be regarded as an external value of domestic currency in terms of other foreign currencies. Simply the rate is parity between two currencies. The rate at which one currency buys exchanges for another currency is known as foreign exchange rate. The rate of exchange is expressed in foreign exchange market in two ways: 1. Expressing the rate in terms of domestic currency. By taking the one unit of foreign currency we take the value of domestic currency. For example, one US dollar is equal to forty Indian rupees. This is also called as direct rate. Direct method: US $ 1 = Rs. 40.00 2. Expressing the rate of exchange in terms of foreign currency or indirect rate method In this method, the home currency unit is kept constant and foreign currency unit is varied. The rate is stated to be quoted in the indirect method. Indirect method: Rs. 100 = US $ 2.50

DEFINITIONS
Some important definitions given by prominent economists are given as under: Crowther- It (rate of exchange) measures the number of unites of one currency which exchanges in foreign exchange market for one unit of another. Haynes- Exchange rate is the price of currency stated in terms of another currency. R.S. Sayers- The prices of currencies in terms of each other are called foreign exchange rates. S.E. Thomas- The price of one currency unit in terms of another currency at any particular time is called the rate of exchange between two currencies. P.T. Ellsworth- An exchange rate is frequency defined as the price in domestic currency of a unit of foreign currency. It might equally well be defined as the price in a foreign currency of a unit of domestic currency. Norman Crump- The rate of exchange between two currencies is the amount of one currency which in foreign exchange market will exchange for given amount of the other. In a nutshell, foreign exchange trade can be defined as an exchange ratio of two currencies.

TYPES OF FOREIGN EXCHANGE RATES

These are several types of foreign exchange rates. The important types are as follows: 1. Normal Rate and Actual Rate- Normal or true rate or par of exchange rate is determined by forces that are of different nature from those influencing the actual rate. Normal rate may be fixed through exchange control while the actual rate or the current rate or market rate is determined by the market forced of demand and supply of foreign exchange. This actual rate fluctuates from day to day due to changes in demand and supply but these changes take place around the rate which is called normal rate. The actual rate may be above or below the normal rate. For example, if the normal rate of Re and $ is 40:1 the actual rate may be 42:1 or 38:1. 2. Spot Rate and Forward Rate- The spot rate refers to that rate of exchange at which the delivery of foreign exchange is made to the buyer by the seller at the spot or delivery of currency bought or sold, is immediate. Forward rates at those quoted for forward or future delivery of currency, the rate of exchange is fixed at the time of deal but actual delivery is effected at contacted future date at this rate. The forward rate is quoted either at a premium or at a discount over the spot rate. This rate is calculated by making an allowance of premium or discount or in other words, forward margin is adjusted. 3. Single Rate and Multiple Rates- In general circumstances, there is only one single rate for all purposes. But in certain special circumstances, a country may adopt more than one, two, or three rates with another currency. This is known as the Multiple Exchange Rate system. For example, the government of a country adopts one rate for export and another for imports.

4. Direct Rate and Indirect Rate- From the point of view of expressing the quotation in the foreign exchange market, the rate could be direct and indirect. Under direct rate, the foreign currency unit is kept constant and the home currency is varied, the rate is said to be quoted in direct method. While in indirect method of quotation, the home currency unit is kept constant and foreign currency unit id varied, the rate is called indirect for example: Direct Rate US $ 1 + Rs. 40 / Indirect Rate Rs. 100 = $2.50 5. Buying Rate and Selling Rate-As the foreign market is very lucrative and competitive market, the parties engaged in this business, naturally and to earn maximum profit. The dealers will quote the rates of foreign currencies in two ways. They will give low rate when they will buy foreign currencies in two ways. They will give low rate when they will buy foreign currency and change high rates in case of sale of foreign exchange. These buying and selling rates are quoted on the basis of T.T., M.T. or bills. 6. Favorable Rate and Unfavorable Rate- The rate of exchange can either be favorable or unfavorable to a country. If the external value of the domestic currency increases in terms of the foreign currency, there will be favorable rate and vice-versa. 7. Official and Unofficial Exchange Rates- When the International trade and other transactions are carried on the basis of pre-determined and authorized rates, these rates are called official rates and if the transactions are executed on the basis of other rates, they are called unauthorized and unofficial rates. These rates are also termed as Black Market rates. 8. Fixed and Flexible Exchange Rates: The fixed rates of exchange refer to maintenance of external value of the currency at a pre-determined level that is fixed by the country. Whenever the rate differs from this level, it is corrected through official intervention. After the collapse of gold standard, IMP was instituted under article IV of IMP fixed exchange

rates system was adopted and member countries adopted this system and agreed not to change these rates except in consultation with the fund. This system was abolished in 1978 with the amendment in the article of IMF, still the fixed rates continue in many countries in the form of pegging their currencies to a major currency. The world economy now has been living in an era of flexible or floating exchange rates. Currencies outside their home countries have lost the character of money and have become more like commodities. The flexible free or floating rates refer to the system where the exchange rates are determined by the conditions of market forces viz the demand and supply of foreign exchange in the market. The rates are free to fluctuate according to the changes in demand and supply forces with no restrictions on buying and selling of foreign currencies in the exchange market.

4. THEORIES OF FOREIGN EXCHANGE RATE

In the study of foreign exchange, the determination of exchange rates has special significance. How the rate of exchange is determined under different monetary systems? In this process, different theories have been put forward by economists to explain the rate of exchange between currencies of the different countries. Three important theories covering three different monetary systems are : A. Mint Par Theory B. Purchasing Power Parity Theory C. Balance of Payment Theory OR Demand and Supply Theory

A. Mint Par Theory

When the two countries are on gold standard their currencies are also either in gold coins or convertible into gold at fixed rate. The rates between these two currencies are determined by the par of exchange. This par of exchange between countries is, in the words of S.E. Thomas, called the Mint Par of Excellence the mint par exchange is an expression of the ratio between the statutory bullion equivalents of the standard monetary units of two countries on the same metallic standard. For example, before 1914, England and France were both on gold standard, their mint par was 25.2215 Francs to 1 . Under this mint par English will get 25.2215 Francs in Paris by paying 1 in London. Thus, under the mint par of exchange, the gold contents of the two currencies are evaluated and rate established. It is an equality of gold contents of the currencies. Gold point the actual rate in the market will differ from the mint par rate but the variation will be within two well-defined limits set by the upper and lower gold points . Also called the Specie point , these points or limits are determined by the cost of transportation of export or import of gold from or into the country. This theory is valid only in those countries which are on the gold standard or other precious metallic standard like silver standard. If one country is on gold standard and the other on silver standard, the par of exchange will be determined by the price of gold in terms of silver in the country on silver and price of silver in terms of gold in the gold standard country. Now in world economy, there is not a single country either on gold or silver standard. Thus, the theory has lost its significance. This discussion is now of purely academic interest.

B. Purchasing Power Parity Theory

The determination of exchange rate is very difficult if both the countries are having inconvertible paper currencies. The exchange rate under paper currency standard rate is determined by the theory of purchasing power parity. This theory was propounded by the well-known Swedish economist Prof. Gustav Cassel in 1922, according to some economists this theory was first developed by John Wheatley in 1802, later it was given a scientific shape by William Blake in 1810. Afterwards, the famous classical economist David Ricardo also improved it. Gustav Cassel put it in a refined and presentable formMEANING OF PURCHASING POWER PARITY: The rate under this theory is determined on the basis of relative price level or purchasing power. According to Gustav Cassel - The rate of exchange between two currencies must stand essentially on quotient of the internal purchasing power of these currencies . G.D.H. Cole The relative values of national currencies, especially when they are not on the gold standard are determined by their relative purchasing powers in terms of goods and services . J.M. Keynes- The rates of foreign exchange between two currencies move in the same way as the ratio of an international index expressed in the prices of one currency to the same index expressed in the price of the other country . S.E. Thomas- The rate of exchange tends to rest at that point which expresses equality between the respective purchasing powers of the two currencies. This point is called the purchasing power parity . Crowther- The ratio of exchange between two currencies tends to be the same as the ratio between their respective purchasing power .

EXPLANATION OF THE THEORY This theory holds that the rate of exchange between two currencies depends upon their relative purchasing power in the countries concerned. For example, if one combination of goods containing a certain quality of each of a given list of articles which is purchased in India for Rs. 400 and the same combination in USA in $ 10 the rate of exchange between these currencies is $ 10 = Rs 400 $ 1 = Rs 40 If prices increase in one country it means the purchasing power of the currency has gone down. It will become cheaper in relation to the currency of other country and vice versa. If in this example the cost of goods rises in India from Rs 400/- to 450/- and remains constant in the USA, the revised rate will be $ 10 = Rs 450 $ 1 = Rs 45

CRITICISM OF THE THEORY This theory has been criticized on the several grounds. Some of them are summarized as under: 1. Difficulty in Measurement of Accurate and Proper Purchasing Powers- There is no proper measurement by which the purchasing powers of different currencies can be measured it is based on price indices which are also full of defects likea. They are concerned with past prices not the present, the lose their importance in real life. b. Prices are included for those commodities which are not internationally traded. c. They do not include same commodities but the theory is valid only when the goods compared are same. This is seldom possible. d. They pose the problem of choosing the correct base year. e. Problem of inclusion of identical goods. 2. Neglects Other Factors- The theory asserts that the rate of exchange as determined by the purchasing power of money. But in real life, the rate is influenced by many other factors like exchange control, speculation activities, transfer of capital expansion of trade etc. These factors are being ignored by this theory. 3. Long-Term Theory-This theory does not explain the rate in short run period. This omits all such factors which have importance in shot period.

4. Price level also influenced by Exchange Rate- As this theory is based on the assumption of free trade but in practical life it is not true because each country introduces several types of controls in its economy. 5. Neglects the Demand and Supply of Foreign Exchange- this theory does not give due importance to this aspect of demand and supply which is the base of the general theory of value.

6. Assumption of Free Trade is not Practical- As the theory is based on the assumption of free trade but in practical life it is not true because each country introduces several types of controls in its economy. 7. Against the Practical Experience- It is also argued that in many countries the exchange rate of the currencies could be high against the increasing price level in the economy and vice versa. For example, before 1971, the value of US dollar was increasing despite the rising internal level of prices.

8. Wrong Assumption of Elasticity of Demand- This theory assumes this wrong assumption that the elasticity of the demand of the goods of the country is equal to unity in reality; the demand in foreign countries does not vary in proportion to the changes in the price. 9. It neglects the Duality of Goods- The goods in both countries differ in quality. They cannot have the same quality and standard of goods and this fact is being neglected by theory.

10. One-sided and Incomplete Theory- this theory is based on only one factor the general price level or purchasing power of money and does not furnish explanation of other elements which affect the rate. Thus, this theory is termed as one-sided and incomplete theory. 11. It Neglects the Cost of Transportation- This theory does not take into account the transportation cost. These, transportation cost and other expenses on advertising packaging may disrupt the purchasing power parity.

12. Assumption of a Given Rate- This theory starts its explanation with a give nrate of exchange. How this given rate is arrived at or determined is not explained. This is a serious defect of this theory. 13. It Neglects the Price of Service- The value of services like insurance, banking, travels, communication also affects the rate. Service transactions ignored by this theory.

14. It Neglects the Influence of Capital Movement- According to Keynes; rates are influenced by the capital movement. 15. It does not take into account the elasticities of reciprocal demand. 16. All the goods have no equal and proportional influence on exchange rate. 17. It ignores technological developments which add to the productivity and make goods cheaper and better. This theory is only a partial explanation on the determination of exchange rates.

MERITS OF THEORY Despite all criticism leveled against the theory, it has not lost its importance. If we take into consideration the following points: 1. It is applicable to all currencies of all sorts of monetary standards. 2. It explains the determination of rate on the basis of purchasing power parity. 3. It also explains the changes in the rates as well as the direction and limits of the changes. 4. It establishes a close relationship between the internal price level and the rate of exchange. 5. It explains the nature of trade and balance of payment. 6. It is superior to the old and classical theory. 7. It explains how the rate is affected by the depreciation and appreciation of its currency. Thus, theory cannot be altogether discarded as it is definitely am improvement over the previous classical theory.

C. Balance of Payment Theory/ Demand and Supply Theory

This theory is also known as the general theory and modern theory of exchange rate. It has linked itself with the general equilibrium theory of value. It is supposed to be the most satisfactory explanation of the determination of the rate of exchange. According to this theory, the rate of exchange is determined by the demand and supply of foreign exchange in the exchange market. The exchange rate tends to equate the demand and supply of foreign exchange. The rate of exchange is only a price, the price of the foreign currency in terms of the domestic currency. Like any other price, the rate of exchanges also determined by the market forces of demand and supply. The demand and supply refer to the demand and supply of the foreign exchange in the foreign exchange market. The rate of exchange is determined at a point where there is a parity, equality or equilibrium between demand and supply. Thus, it is also known as the Equilibrium Rate Of Exchange . The rate of exchange will change with the changes in demand and supply of foreign exchange. If there is a surplus in the balance of payments of a country, the supply of foreign exchange will be more, the demand and rate will decrease and vice versa.

Merits 1. It is more Comprehensive It includes almost all factors which influence the rate of exchange. 2. It is Practical and More Realistic- As it recognizes the price of foreign currency is the function of many significant variables and not merely the purchasing power it could be termed as practical and realistic theory. 3. It is part of General Equilibrium- Analysis because it facilitates that analysis. 4. It shows the possibility of adjustments imbalance in the balance of payments more clearly rather than through deflation by the purchasing parity theory so it is more appropriate method of correcting disequilibrium. 5. It Provides Constructive Suggestions- This theory provides better and constructive suggestions to correct if there are imbalances in balance of payment like devaluation and appreciation in the value of money.

Demerits The theory also suffers from several drawbacks. On following grounds it is criticized: 1. Unrealistic Assumptions- This theory is also based on certain unrealistic assumptions like the assumption of perfect competition. 2. Items of Balance of Payments are not Constant- There are frequent changes in the factors contributing to the demand and supply or the terms of balance of payment. 3. Exchange Rate also Affects Balance of Payments- Balance of Payment itself is a function of the rate of exchange and it is influenced by the rate of exchange. 4. No Free Movement of Money- As assumed by the theory there is no such free movement of money from one country to another. 5. It Neglects General Price Level- This theory does not give due importance to the price level of the economy as it assumes that there is no casual connection between the rate of exchange and the price level. Actually, there is a close relationship between the two because the price cost structure affects the balance of payment position. 6. Demand for Raw Materials Not Perfectly Inelastic- This assumption of the theory as also wrong because in practical life, the demand for raw material is not perfectly inelastic and they do affect the demand and supply of foreign exchange. 7. The Theory is Indeterminate- It is also argued that this theory is indeterminate and confusing as to what determinates what. 8. Assumption of Balances of Payment as a Fixed Quality- This assumption that the balance of payment is a fixed quality is not true because it varies with the changes in the internal and external price levels. 9. The balance of payment theory is a mere truism or it is self evident- Despite these criticisms, the demand and supply theory is termed as the most satisfactory and comprehensive theory in the field of the exchange rate determination.

5. FOREIGN EXCHANGE RATES FLUCTUATIONS

Once a country determines the rate of exchange, this rate of exchange between two countries is seldom constant. In real life, the exchange rate keeps on fluctuating from time to time in all types of economies and in all types of rates of exchanges. It is so because of the multitude of factors that affects exchange rates. No single factors can be singled out as the sole determinant. The rate is the outcome of many forces at play exerting their their influences. Not all factors that affect fluctuations in the rates are equal in importance, some factors particularly the economic factors are better guides in the long run while certain immediate factors may affect in short run. The fluctuations in the rate create uncertainty which have so many harmful effects and repercussions on flow of trade and investment. A market based exchange rate will change whenever the values of either of the two component currencies change. A currency will tend to become more valuable whenever demand for it is greater than the available supply. It will become less valuable whenever demand is less than available supply .Increased demand for a currency is due to either an increased transaction demand for money or an increased speculative demand for money. The transaction demand for money is highly correlated to the country's level of business activity, gross domestic product (GDP), and employment levels. The more people there are unemployed, the less the public as a whole will spend on goods and services. Central Banks typically have little difficulty adjusting the available money supply to accommodate changes in the demand for money due to business transactions. The speculative demand for money is much harder for a central bank to accommodate but they try to do this by adjusting interest rates. An investor may choose to buy a currency if the return (that is the interest rate) is high enough. The higher a country's interest rates, the greater the demand for that currency. It has been argued that currency speculation can undermine real economic growth, in particular since large currency speculators may deliberately create downward pressure on a currency by shorting in order to force that central bank to sell their currency to keep it stable

CAUSES OF FLUCTUATIONS 1. Change in the demand and supply of foreign exchange

The changes in demand and supply of foreign influence the balance of payment of a country in short term and also affect the aggregate volume of capital movement. These changes in demand and supply will either increase or decrease the rate depending upon the changes in the supply and demand of foreign exchange.

2. State of international trade

The state of international trade of a country or changes in the volume of imports and exports will also affect the rate. If there is adversity in trade and it increases further, this deficit in trade will adversely affect the rate and vice versa in case of a favorable trade balance.

3. Monetary policy
Monetary policy particularly the regulation of money supply and frequent changes in money supply will affect the fluctuation in rate of exchange.

4. Capital movement
External borrowing assistance and aid and other financial foreign investment will affect the exchange rate.

5. Industrial factors
In case of industrial development, there is more investment of foreign capital and rate will be favorably affected and vice versa.

6. Currency conditions
The currency conditions also deeply affect the rate of exchange:-

i. INFLATION Due to decrease in purchasing power, the rate turns against the country. ii. DEFLATION Due to deflation, there will be more foreign capital into the country and the rates will turn in favour of the country. iii. DEVALUATION The policy of devaluation will also affect the rate as it will affect the import, export and capital movement.

7. Political conditions
There are several political factors which also affect the rate, like political stability in the country. The position of peace or war or national security problems, heavy expenses on defense etc. 8. Exchange control A country will like to stabilize the rate through various measures of exchange control. The exchange control invariably affect exchange rate. 9. Capital market and Stock exchange condition The rate is also influenced by various transactions performed at stock exchanges or capital market. As it is well known various types of securities like shares, stocks, debentures, bonds are bought and sold every day on the stock exchanges and they affect the demand and supply of foreign exchange. 10. Banking condition Many factors related with banking also influence the rate like:y Bank rate of the Central bank y Arbitrage operations y Sale and purchase of bills, instruments and traveler cheques etc. y Issuing of credit instruments

11. National income Increase in national income will lead to an increase in investment, productions and consumption and accordingly these it will have effect on the exchange rate. 12. Psychological factors It has powerful influence on exchange rates sometimes aggravating the trend set by other factors. The BULL (purchasing heavily expecting a rise in price ) and BEAR (selling heavily expecting a fall in price ) operations are the example of psychological factors. 13. Technological and Market factors There are huge isolated transactions in the market and seasonal variations in the demand and supply. These factors may upset the balance of demand and supply of foreign exchange. 14. Activities of middleman and brokers These activities are carried out to dispose off securities by buying in cheaper market and selling in the expensive and costlier security markets to earn profit by the brokers and these activities affect the demand and supply of foreign exchange. It naturally affects exchange rate.

LIMITS OF FLUCTUATIONS
It is also necessary to know the upper and lower limits of fluctuations under various monetary systems. The fluctuations in the rate takes place within certain well- defined limits under the given situations: 1. Under Gold Standard Under this system, the rate of exchange is governed by the gold points; the rate invariably remains within the gold points. It neither increases above the upper gold point nor does it decreases below the lower gold point. 2. Under Paper Currency Standard Under this, rate of exchange tends to be fixed around the purchasing power of the currencies of two countries .But in this case, there are no definite limits within which the rate will fluctuate or in other words, rate of exchange can rise and fall to any limit. 3. Under Mixed System : One country on Gold and another on Paper Currency Standard In this case for a country having gold standard, the change in the rate of exchange is restricted to the upper gold point and there is no lower limit. For country having paper currency standard the rates can fall and rise both ways without any limit.

EFFECTS OF FLUCTUATIONS
The fluctuations in rate of exchange have far- reaching effects for an economy. As we know the fluctuations take place both ways wither increasing or decreasing the rates. These both trends have different and opposite effects on the various aspects of the economy. If there is an increase in the value of the currency of the country, it will have positive effects on all aspects of the demand and supply of foreign exchange like import and export of goods and services, capital movement and overall economic development of the country , in the contrary situation if the value of currency is going down in terms of other foreign currencies, it will have negative effects on all aspects of the balance of payments or demand and supply of foreign exchange of the country. For example this trend will adversely affect the international trade, investment capital movement and other international monetary transactions. Ultimately, the overall economy is highly victimized of so many abuses of low development, low income low production, low saving and investment and low employment. So in order to have better and positive effects, a country should check and control the highly adverse fluctuations in the exchange rate.

METHODS OF CONTROL
The problem to control and check violent and adverse fluctuations in the rate of exchange and for getting stability in the rate largely depends upon the equilibrium in the demand and supply forces of foreign exchange or in the different items of balance of payment. Some of the important measures of control a country could resort to are mentioned below:1. Minimization of trade deficit A country should take all possible efforts to boost export and control import to remove trade imbalance or at least minimize it. This trade imbalance can be removed or minimized by taking such steps: y Imposition of import duties y Export incentives and other 2. Correcting all causes of adverse effects Whatever causes which have been discussed should be corrected favorably for better position. 3. Depreciation or Devaluation of Currency For good results in external sector of the economy, a country can depreciate or devalue its currency in terms of other foreign currencies. 4. Monetary and Currency Measure By making appropriate changes in the monetary policy and taking some monetary measures like change in bank rate may help a country to achieve stability in the rate. 5. Curbing Speculative Activities Speculation gives birth to high fluctuations .All efforts should be made to curb speculative activities in the foreign exchange market. 6. Control on Capital Movement A country can introduce various control measure, to control the capital movement particularly the outflow of capital.

7. Introduction of exchange control Through various methods of exchange controls like intervention, restrictions and agreements a country can improve the situation and ensure greater stability in the exchange rate. 8. Creation of Foreign Exchange Reserve For stability in the rate and for other purposes a country should create sufficient reserve of clear foreign currencies in order to meet the emergent need and overcome the uncertain circumstances. 9. Freedom from Political and Economic Crisis A country by all means should make itself free from all political and economic crisis in order to have positive results in its favour in the field of foreign exchange market.

6. FOREIGN EXCHANGE CONTROL

Foreign Exchange Control refers to the control of international monetary and economic transactions involving foreign exchange either by government directly or a centralized agency like central bank. These are various forms of controls imposed by a government on the purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by nonresidents. Common foreign exchange controls include:
    

Banning the use of foreign currency within the country Banning locals from possessing foreign currency Restricting currency exchange to government-approved exchangers Fixed exchange rates Restrictions on the amount of currency that may be imported or exported

Countries with foreign exchange controls are also known as "Article 14 countries," after the provision in the International Monetary Fund agreement allowing exchange controls for transitional economies. Such controls used to be common in most countries, particularly poorer ones, until the 1990s when free trade and globalization started a trend towards economic liberalization. Today, countries which still impose exchange controls are the exception rather than the rule. In this exchange control, free play of market forces is restricted by certain regulative measures in the exchange market. The rate of exchange under this system will naturally be different from one that will exist in the absence of such control. In today s world economy, almost all the countries in the world have adopted some form of exchange control or other. In some it exists in its extreme form with al its complexities. The control extends over all transactions of international receipts and payments are centralized and all payments are rationed. The countries proclaiming to abolish the exchange control also have some forms of the control. Thus it is difficult in present times to conceive of an economy which is absolutely free from all sorts of exchange control.

Regulation at government level of money-flows in and out of a country. Exchange controls are usually maintained in the belief that they help to protect a country's currency and its foreign-exchange reserves. The controls may restrict investments by residents overseas and non-residents' investments and participation in the local market. Big international currency movements tend not to obey such controls. Sometimes individuals are limited in the amount of currency they may take abroad for holidays. The UK abandoned exchange controls in 1979. In Australia, exchange controls which had persisted in one form or another since 1939 were virtually abolished in December 1983 when the $A was floated. Types of controls that governments put in place to ban or restrict the amount of foreign currency or local currency that is allowed to be traded or purchased. Common exchange controls include banning the use of foreign currency and restricting the amount of domestic currency that can be exchanged within the country. Typically, countries that employ exchange controls are those with weaker economies. These controls allow countries a greater degree of economic stability by limiting the amount of exchange rate volatility due to currency inflows/outflows. The International Monetary Fund has a provision called article 14, which only allows countries with transitional economies to employ foreign exchange controls.

THE ORIGIN OR EVOLUTION OF EXCHANGE CONTROL

The origin of the foreign exchange control can be traced back to thirties. After the World War I, the Germany adopted exchange control to stabilize its continuously depreciating mark. After it in the same contemporary period, almost all the European countries resorted to this technique and after World War II almost all the countries of the world have adopted this technique of exchange control. There is hardly any country today which has not adopted in one form or the other the system of exchange control. Now there is growing control over the movement of exchange for several reasons.

MEANING OF EXCHANGE CONTROL

The foreign exchange control is a system in which a country introduces some regulatory measures to curb the free play of market forces in the foreign exchange market. The government imposes control on the purchase and sale of foreign currencies in that system. The term exchange control is used in two different senses the wide sense as well as the narrow sense. In the wide sense, the term exchange control refers to all those intervening activities of government which are intended to influence the rate of exchange or the business connected with the foreign exchange and also includes such things as the imposition of control on exchange rate , exchange equalization accounts as well as the conclusion of trade and payment agreement with other countries. In narrow sense, the exchange control refers to these restrictions which are imposed by the government on foreign exchange business. G.N. Halmes By exchange control we refer to measures which replace part of the equilibrium functions of the foreign exchange market by regulation alien to the pricing process. Haberler Exchange control is the state regulation for excluding the free play of economic forces from the foreign exchange market.

P.T. Ellsworth Exchange control means dealing with the balance of payment difficulties disregards market forces and substitutes for them the arbitrary decisions of government officials. Imports and other payment are no longer determined by the international price comparisons but the considerations of national need. Kent Exchange control may be defined as government action to regulate exchange rate and restrict the use of the means of international payment. Evitt Any form of official interference with the freedom of dealings in foreign exchange is exchange control.

CHARACTERSTICS OF EXCHANGE CONTROL

1. All types of international transactions involving foreign exchange are centralized. 2. State has full control over the foreign exchange business in the market. 3. Only hose possessing license can deal in foreign exchange. 4. The government fixes the priorities for distribution of foreign exchange . 5. The whole foreign exchange is deposited with central bank which gives the exporters domestic currency in return. 6. The importers get foreign currency from the central bank. 7. Rate of exchange is determined officially by the government and it is also managed.

MERITS OF EXCHANGE CONTROL

y It maintains exchange rate stability. y It is aimed to keep the exchange rate in the economy different from the market exchange rate. i. Under Valuation This policy is adopted for curing the depression. Under this system, the country fixes rate lower than it would be in a free exchange market .It will give stimulus to export and domestic industries and import will be discouraged. As the result, balance of trade and payments turn in favour of the country. ii. Over Valuation In this objective, a country fixes the value of its currency at a level higher than it would be if there was no intervention in foreign exchange .It is adopted when the country is suffering from inflation and to meet the large debt payments expressed in foreign currency and the country in need of foreign goods. y It intends to iron out temporary ups and downs and this is done through exchange equalization account. y It also aims to correct persistently adverse balance of payment. y It helps in conserving country s depleting gold reserves and foreign exchange reserves. y With exchange control country also regulates capital movement in order to prevent the flight of capital from the country. y Country with exchange control aims objective for its economic growth with stability. y Exchange control done with a view to encourage trade with a particular country or group of countries (trade block), this is called bilateralism.

y Exchange control provides protection against the tough foreign competition. y Exchange control helps in proper execution of the economic plans and developmental planning in the country. y It removes the imbalance and deficit in the international trade by restricting foreign exchange to the importers for importing goods. y The Government may prohibit the import of certain commodities altogether with the help of exchange control. y It could be utilized to earn profit by keeping a wide margin between buying and selling rates of foreign exchange. y Through exchange control, a country can adjust the domestic demand and export and import .By this adjustment a country can maintain internal price stability. y Through exchange control, a country tries to escape from the abuses of international economic crisis. y Exchange control facilitates in making orderly and timely international debts and other payments. y Exchange control also maintains the fixed and stable relations with important currencies to which they have more transactions.

DEMERITS OF EXCHANGE CONTROL

y As all control gives birth to the dichotomy in the economy and encourage political and administrative corruption in the country. y Under exchange control, a country puts an end to the working of a principle of comparative cost. In this, a country also produces those commodities in which it does not enjoy advantages. y A country has to employ an army of competent officials which is not feasible for underdeveloped countries. y It generates the feeling of fulfilling national interest at all costs and this ultimately creates tension among international community. y Due to exchange control, there are more fluctuations in the international economy which encourages the working of business cycles. y It is against the consumer s interest. y It obstructs Economic cooperation internationally. y It discourages multilateral trade. y In the long run, exchange control results in the creation of fundamental disequilibrium which is more harmful for the economy. y The criteria laid down for the various types of control are arbitrary in nature. y Exchange control puts several restrictive measures in the way of free trade; it will reduce the volume of international trade.

y It also presents several hurdles and obstacles in establishing specialization in production of several commodities because of imposing of several restrictions on free trade. y Exchange control is also not conducive for free flow of capital movement and investment and that is not in the interest of the economy.

METHODS OF EXCHANGE CONTROL

The methods are classified in two groups: 1. Direct and Indirect Methods 2. Unilateral, Bilateral or Multilateral Methods Direct method is that method which directly aims to control foreign exchange and stability of exchange rates while indirect method does not affect the exchange rates directly. They are primary aimed to certain other fields of the economy but their working will so influence the rate of exchange. Unilateral method are those methods which are adopted by a country unilaterally without taking into confidence or understanding with other countries . Bilateral or Multilateral methods are those methods when two or more countries adopt certain measures to control the exchange trade. These methods have repercussions on all countries which jointly resort to this system. A. UNILATERAL METHODS 1.) Exchange Intervention or Exchange Pegging It is the mild form of of exchange control under which the government intervenes in the free play of market forces of demand and supply of foreign currency with a view to keep the rate at desired level. If the government wants to keep the rate higher than the rate which would prevail in the free exchange market, the currency is said to be Pegged Up and in a vice versa situation Pegged Down . This intervention in the rate by pegging up and pegging down does not cause permanent change in the rate of either upwards or downwards. 2.) Exchange Restrictions In these methods a country resorts to more powerful methods for exerting exchange control. The country restricts the demand and supply forces of foreign exchange by these

methods. A government can employ following popular measures of restrictions:i. Blocked Account Under this technique, the government imposes restrictions on the banking account of foreigners who are not allowed to withdraw money from them. Sometimes, the entire amount is transferred to one Blocked account. This device harms the reputation of the country it should be adopted only in war time or in grave extraordinary circumstances. ii. Multiple Exchange Rates Under this, a country fixes different rates for import and export and for different countries and for many other purposes like different rates for capital outflows and inflows. It is rationing of foreign exchange by price rather than by quantity. It is a complex system and increases burden of central bank. It may also create a lot of confusion. It is not very feasible system. iii. Rationing Of Foreign Exchange Under this, a country puts an end to free sale or purchase of foreign currencies .All foreign currencies are to be surrendered at a fixed rate and all requirements of foreign exchange are rationed and allocated on a priority. iv. Exchange Equalization Fund It is also called exchange stabilization fund. The main objective of t his fund is to control short run fluctuations in the rate of exchange. It was adopted by Britain in 1932 an soon after followed by USA, France, Switzerland and other European countries.

B. Bilateral or Multilateral Methods 1. Payment Agreements This is the only form of rationing of foreign exchange. Under the payment agreement between the debtor and the creditor country, the provision is made for the repayment to overcome the difficulties of delay involved in setting international payments. The payment agreement controls fluctuations in the rate by resorting to controlled distribution and rationing of foreign exchange. 2. Clearing Agreements Under this, the importers of the countries make the payments for the imported goods not in terms of foreign currencies but in terms of domestic currency which is deposited in the clearing accounts of their respective countries .Likewise, the exporters in the two countries receive the payments of their exports not in foreign currencies but with the help of clearing accounts of their respective countries. So there is no need of foreign exchange for both imports and exports as the payments are made through this in situation of clearing accounts with their central banks. This method was first practiced in Germany and Switzerland in 1930 during the period of great depression. 3. Stand Still Agreements Under this system, a country prevents the movement of capital through a moratorium on outstanding short term debts and to give time to put the position in order, or in other words, the short term debts are converted into long term debts and provision is made for gradual repayment. This system was first adopted in Germany after the crisis of 1931.

4. Compensation Agreement Under this system, the countries just enter into agreement of barter type of import and export in which there is no transaction of foreign currencies .The imports and exports values of the two countries exactly balance each other. 5. Transfer Moratoria Under this, the government puts a ban on all payment to foreigners or creditors. The local debtors make the payment due to their foreign creditors to the central bank. The funds released by the central bank to the foreigners when the reserve position or overall balance of payment situation of the country improves.

II. Indirect Methods 1. Bank Rate Regulation The rate of exchange can be controlled by raising or decreasing the bank rate. This change will affect the demand and supply of money. An increase in bank rate will attract foreign capital into the country and the demand for domestic currency will increase in the exchange market .As a result, the rate of exchange will go up in relation to other foreign currencies, the contrary situation happens when the bank rate is lowered. 2. Regulation of International Trade Through controlling international trade also, a country regulates its exchange control mechanism. If the balance of trade is unfavorable in such a situation, the government will control the rate of exchange by regulating the imports of the country and giving all possible incentives like exports subsides to exports.

3. Changes in Tariffs A country by changing its tariff rate structure also can influence the rate of exchange. 4. Gold Policy Exchange control can also be affected by manipulating the buying and selling price of gold. Such a policy affects exchange rates through its effects on the gold points in 1936 under a Tripartite agreement between USA , France and the USA sought to control exchange rate by fixing the purchase and sale prices of gold at a level at which these parties proposed to be fixed up the exchange rate. 5. Quota System For improving the deteriorating situation of the exchange rate, a country can resort to this technique of fixing up of import quota. In value and quantity both the quota system may be under international commodity agreements between importing and exporting country. 6. EXIM policy A country through various policy measures of its export and import policy can also manipulate the exchange rate. 7. All Corrective Measures to improve Balance of Payment All measures which a country can take to improve its position of balance of payment will also affect the exchange rate and those measures can also be use as methods of exchange control like policy of devaluation, import controls and restrictions and export promotion etc.

7.EXCHANGE CONTROL IN INDIA

ORIGIN
In India, exchange controls were firstly introduced on September 3, 1939, by government of India. Immediately after the outbreak of second world war , no exchange controls were administered before this introduction , though during first war there were fluctuations in the exchange rate of Indian Rupee in terms of sterling and it encouraged speculative activities and produced adverse repercussions on the country s trade. With the introduction of exchange control in 1939 , the government empowered the Reserve Bank of India under the Defense of India Rules (DIR(, to administer the exchange control of India .The RBI then setup a separate Exchange Control Department for the proper administration of the exchange control. In 1939 itself RBI enunciated its exchange control policy for the benefits of exporters and importers and to conserve the non sterling area currencies to utilize them for essential purposes. Due to these developments, it became clear that foreign exchange control would have to continue in some form or the other in the post war period also in the interest of making the most prudent use of the foreign exchange resources. It was felt necessary to continue the exchange control on a systematic and long-term basis. It was; therefore, decide to place the exchange control on a statuary basis and the FOREIGN EXCHANGE REGULATION ACT of 1947was enacted. This act since been replaced by the act of 1973and then after liberalization of the economy with many modifications with a new name. It was further replaced by foreign exchange management act 1999 (FEMA). Over the years, the scope of exchange control ha substantially widened and the regulations have become more progressive in view of the increasing demand of foreign exchange for the planned development. It became an integral part of the planned process of development. Its scope was far the extended to sterling area and after 1951 Pakistan and Afghanistan also came into its fold.

Exchange control in India is administered by the RBI. It is related to and supplemented by trade control the responsibility of which has been entrusted to chief controller of imports and exports now redesignated as Director General Foreign Trade (DGFT) under the ministry of commerce. For trade control in our country, we enact the imports and exports control act 1947 which has been replaced by the Foreign Trade Development & Regulation Act (FTDRA) 1992. Under the exchange control, the RBI had empowered selected commercial banks to deal in foreign exchange. In other words, the sale and purchase was to be conducted by these banks only. A major portion of foreign exchange dealings is dealt with these banks in India which have been authorized by RBI to deal in foreign exchange as Authorized Dealers in foreign exchange.

OBJECTIVES OF EXCHANGE CONTROL IN INDIA

(i) Protection of Balance of Payments. One of the important objectives of exchange control is protection of balance of payments. When the balance of payments deficit of a nation becomes large a chronic and its automatic correction is not possible, certain active measures have to be adopted. In normal times the adverse balance of payments caused value of country's currency to fall and helps in restoring equilibrium. (ii) Reducing Burden of Foreign Debt. The exchange value of a currency is sometimes fixed and maintained at higher level to lighten the burden of foreign debts contracted in terms of foreign currencies. By overvaluing currency, the foreign exchange earnings of the country from exports are increased in cases where the demand is inelastic and the prices in terms of the home currency to be paid for essential imports get reduced. (iii) Raising the Level of Prices. Sometimes the currency is undervalued to help in raising certain conditions in thought desirable to stabilize the exchange rate at what can be called the equilibrium level, i.e., the level determined by market forces. Short-term fluctuations are eliminated by deliberate action of authorities. (iv) Elimination of Short-term Fluctuations in Exchange Rate. Exchange regulation in certain conditions is thought desirable to stabilize the exchange rate at what can be called the equilibrium level, i.e., the level determined by market forces. (v) Prevention of Export of Capital. When the country suffers from exceptionally heavy outflow of capital caused by loss of confidence on the part of nationals of the country or foreigners in the economy of the country or its currency, certain exchange controls over remittances from and the country are necessary.

(vi) Economic Planning. Exchange control is an important part of economic policy in any planned economy. Planning involves a very careful use of foreign exchange resources of the country so that only those goods are imported which are essential for the implementation of the plans. Exchange controls are resorted to regular the exports and imports in the light of plans. (vii) Encouragement of Certain Economic Activities. One of the objectives of exchange regulations is to encourage certain economic activities in the country. Certain industries can be developed by reducing the imports of commodities produced by them and restricting the availability of foreign exchange to pay for them.

FEATURES OF EXCHANGE CONTROL IN INDIA

1.) Authority of Control The main authority in this field is entrusted to Finance Ministry of Government of India and Reserve Bank Of India. For smooth implementation of the exchange control, RBI takes t he help of several authorized dealers and authorized money changer etc. 2.) Foreign Currency Receipts Any person earring foreign exchange from any source has to surrender before authorized dealer .It can keep up to $500 with him. A foreign tourist can bring foreign money without any limit. Any person ridding abroad can remit up to $5000 as gift instead of previously $1000to the relative or friend in India.NRIs can remit money without any limit. 3.) Foreign Currency Payments In making foreign payment for various purposes like imports of goods and services , education, tourism and travel, transportation , insurance . For all these payments liberal rules have been framed in comparison to previous rules of FERA .A person can remit the amount of $25000 without the permits of RBI for foreign visit. 4.) Administration The FEMA has assigned more powers to RBI in the administration of exchange control in the country. RBI has its own foreign exchange control department under the direct control of the governor of the bank. There are several other deputy controllers to look after its sub-offices at Mumbai, Kolkata, New Delhi, Chennai and Kanpur. The FEMA provides for appointment of director enforcement for taking up investigations of the contraventions under this act.

5.) Exchange RatesAfter delinking of Indian Rupee with pound sterling. The exchange rate of Indian rupee is fixed in accordance with a basket of selected currencies. Now the value of rupee floats according to the relative demand and supply of foreign exchange. In emergent situations, the RBI has power to manage the fluctuations. 6.) Convertibility of the Rupee Free convertibility of a currency means that the currency can be exchanged or converted for any other currency without any restrictions at the market determined exchange rate. Convertibility of the rupees thus means that the rupee can be freely converted into dollar, pound, and euro, yen etc. and vice versa at the rates of exchange determined by the market forces of demand and supply. 7.) Enforcement of Money Laundering Prevention Act 2002 The government of India enacted an act in 2002, the money laundering prevention act to prevent unlawful money into the country. 8.) Superiority of FEMA over FERA FERA to FEMA marks a positive shift from control to management of foreign exchange there are several grounds on which we can conclude that the FEMA is superior in comparison to FERA .Some of the grounds are I. Many provisions of FERA like the ones relating to blocked accounts, Indians taking up employment abroad, employment of foreign technicians in India vexations search etc. have no appearance in FEMA. II. There is lot of deregulation as FEMA only regulates foreign exchange and FERA controls everything that has to do with foreign exchange. III. FEMA is much smaller enactment having only 49 sections against 81 of FERA.

IV. FEMA has more liberal and transparent rules regarding foreign investment in comparison to FERA. V. Contravention under FEMA is liable only for penalty up to thrice amount involved while it was five times in FERA with provision of imprisonment. VI. The contravention in the FERA is dealt as a criminal offence and there are provisions of imprisonment also in addition to penalties while in FEMA violations, it dealt as civil matters and there is provision of only penalty. VII. The liability of proving the crime is on the party in FERA but in FEMA it lies on enforcement agency

8.FOREIGN EXCHANGE MARKET

OVERVIEW
In today s world no economy is self sufficient, so there is need for exchange of goods and services amongst the different countries. So in this global village, unlike in the primitive age the exchange of goods and services is no longer carried out on barter basis. Every sovereign country in the world has a currency that is legal tender in its territory and this currency does not act as money outside its boundaries. So whenever a country buys or sells goods and services from or to another country, the residents of two countries have to exchange currencies. So we can imagine that if all countries have the same currency then there is no need for foreign exchange. Foreign exchange market is described as an OTC (over the counter) market as there is no physical place where the participants meet to execute the deals, as we see in the case of stock exchange. The largest foreign exchange market is in London, followed by the New York, Tokyo, Zurich and Frankfurt. The markets are situated throughout the different time zone of the globe in such a way that one market is closing the other is beginning its operation. Therefore it is stated that foreign exchange market is functioning throughout 24 hours a day. In most market US dollar is the vehicle currency, viz., the currency used to dominate international transaction. In India, foreign exchange has been given a statutory definition. Section 2 (b) of foreign exchange regulation ACT, 1973 states: Foreign exchange means foreign currency and includes:  All deposits, credits and balance payable in any foreign currency and any draft, traveller s cheques, letter of credit and bills of exchange. Expressed or drawn in India currency but payable in any foreign currency.

 Any instrument payable, at the option of drawee or holder thereof or any other party thereto, either in Indian currency or in foreign currency or partly in one and partly in the other. In order to provide facilities to members of the public and foreigners visiting India, for-exchange of foreign currency into Indian currency and viceversa. RBI has granted to various firms and individuals, license to undertake money-changing business at seas/airport and tourism place of tourist interest in India. Besides certain authorized dealers in foreign exchange (banks) have also been permitted to open exchange bureaus. Following are the major bifurcations: y Full fledge moneychangers they are the firms and individuals who have been authorized to take both, purchase and sale transaction with the public. y Restricted moneychanger they are shops, emporia and hotels etc. that have been authorized only to purchase foreign currency towards cost of goods supplied or services rendered by them or for conversion into rupees. y Authorized dealers they are one who can undertake all types of foreign exchange transaction. Banks are only the authorized dealers. The only exceptions are Thomas cook, western union, UAE exchange which though, and not a bank is an AD. Even among the banks RBI has categorized them as follows:  Branch A They are the branches that have nostro and vostro account.  Branch B The branch that can deal in all other transaction but do not maintain nostro and vostro a/c s fall under this category. For Indian we can conclude that foreign exchange refers to foreign money, which includes notes, cheques, bills of exchange, bank balance and deposits in foreign currencies.

PARTICIPANTS IN FOREIGN EXCHANGE MARKET

The main players in foreign exchange market are as follows: 1. CUSTOMERS The customers who are engaged in foreign trade participate in foreign exchange market by availing of the services of banks. Exporters require converting the dollars in to rupee and importers require converting rupee in to the dollars, as they have to pay in dollars for the goods/services they have imported. 2. COMMERCIAL BANK They are most active players in the forex market. Commercial bank dealing with international transaction offer services for conversion of one currency in to another. They have wide network of branches. Typically banks buy foreign exchange from exporters and sells foreign exchange to the importers of goods. As every time the foreign exchange bought or oversold position. The balance amount is sold or bought from the market. 3. CENTRAL BANK In all countries Central bank have been charged with the responsibility of maintaining the external value of the domestic currency. Generally this is achieved by the intervention of the bank. 4. EXCHANGE BROKERS Forex brokers play very important role in the foreign exchange market. However the extent to which services of foreign brokers are utilized depends on the tradition and practice prevailing at a particular forex market centre. In India as per FEDAI guideline the Ads are free to deal directly among themselves without going through brokers. The brokers are

not among to allowed to deal in their own account all over the world and also in India.

5. OVERSEAS FOREX MARKET Today the daily global turnover is estimated to be more than US $ 1.5 trillion a day. The international trade however constitutes hardly 5 to 7 % of this total turnover. The rest of trading in world forex market is constituted of financial transaction and speculation. As we know that the forex market is 24hour market, the day begins with Tokyo and thereafter Singapore opens, thereafter India, followed by Bahrain, Frankfurt, Paris, London, New York, Sydney, and back to Tokyo. 6. SPECULATORS The speculators are the major players in the forex market. y Bank dealing are the major speculators in the forex market with a view to make profit on account of favourable movement in exchange rate, take position i.e. if they feel that rate of particular currency is likely to go up in short term. They buy that currency and sell it as soon as they are able to make quick profit. y Corporation s particularly multinational corporation and transnational corporation having business operation beyond their national frontiers and on account of their cash flows being large and in multi currencies get in to foreign exchange exposures. With a view to make advantage of exchange rate movement in their favour they either delay covering exposures or do not cover until cash flow materialize. y Individual like share dealing also undertake the activity of buying and selling of foreign exchange for booking short term profits. They also buy foreign currency stocks, bonds and other assets without covering the foreign exchange exposure risk. This also result in speculations.

9. INTERNATIONAL PAYMENTS
International payment occupies an importance place in the study of international economics. International economic and monetary transactions give rise to receipts and payment in settlement of these transactions .International payment implies movement of funds by way of inward and outward remittances between countries. The entire gamut is focused around the receipts or payments for several economic transactions. From the point of view of smooth flow of trade in goods and services among nations it is essential that receipts and payments are affected on time and without any uncertainty. These requirements are met when internationally accepted methods of payment are used by the countries.

MEANING & CHARACTERSTICS

The International Payment means process of setting international dues and obligations between two parties of different countries .In brief, international payments is the monetary transfer among nations to settle their international obligations and liabilities. In international payment, the payments can be made either to an individual institution or organization or to the government. International payment is difficult and complex mechanisms because of the payments are made in different countries of different value. International payments possess the following characteristics: 1. Two Parties It involves two parties as in internal payment. One party who pays and another party who receive the payments. Like in trade services, the party rendering services will receive payment and parties who take the services from foreign countries will pay for those services similar case will be for all other items of receipts and payments. 2. Transaction Between Two Countries The international payment take place between 2 countries s as the parties belong to different countries money transfer should be made internationally . Transfer of money between

residents of 2 different countries in one country cannot be termed as international payment. 3. Settlement of Economic Obligation International payments are made basically to settle different types of international trade and economic obligations. These obligations are the results of different international economic transactions. 4. International Payment For Non-Economic Activities International payments can also be affected for non economic activities like foreign aid and assistance amount of war compensations, transfer by emigrants. Expenses on diplomatic missions and for giving international prises and awards. 5. Transfer of Value It is not necessary that international payment should be made in money instead of money transfer there should be transfer of value. 6. More Complex It is more complex in comparison to internal payment, due to difference in currencies, fluctuations in their values and existence of exchange control. The following extra difficulties and complexities arise in international payment. I. Different Currencies II. Fluctuations in exchange rate III. Exchange control IV. Difficulty in payment of dear or scarce currencies V. Taking the help of banks and banking system The banking system of a country plays an important role in settling international payments. There is no physical movement of funds or currencies

in settlement of transactions. Receipts and payment create claims on currencies of trading parties and these claims are settled by credits and debits to the accounts of banks in the countries concerned. For this reason, all international payments whether receipts or payments on account of international transactions are routed through the banks, thus , the banking system facilitates international payment. VI. Extra risk in international payment International payments have extra risk sin comparison to internal risk. There are several commercial and political risks. It assumes significance because of complexities and risks. VII. All international payments ultimately result in either inward or outward remittance of funds into or from the country.

METHODS OF INTERNATIONAL PAYMENT

There are several methods of receiving and making payments. The important methods can be classified as under: 1. Payments of imports by exports 2. Payments through transfer of bullion 3. Payments by currency transfer 4. Payments by international money order 5. Payments through banks i. Payment through cheques ii. Payment through traveller s cheques iii. Payment through bank drafts iv. Payment through mail transfer v. Payment through guaranteed mail transfer vi. Payment through telegraphic transfer vii. Payment through foreign exchange bills viii. Payment through letter of credit 1. Payment of Imports by Exports or Exports pay The largest amount of international payments is required to meet the payments for imports and receipts through exports. If both these are fully matched there will be least problem of international payment. Under this, there is no movement of currency. Payment for import is out of the proceeds of export. So it is said that exports pay for imports. 2. Payment through transfer of bullion International payments can also be effected in terms of gold and bullion. This has been a historically traditional method because of its universal acceptability. Now in the present scenario, this method has lost its popularity of olden age because of so many complexities attached to this system.

3. Payments through transfer of currency Under this system, payment can be made in the form of cash or currency with order. The importer pays, in advance or before delivery of goods. He may make payment: i. In the currency of the exporters country ii. In the currency of importers currency iii. In the currency of third currency as agreed, by the parties. Now-a-days, importers instead of paying the entire amount, pay only a proportion of the value of goods in advance and make the final settlement after the delivery of the goods. 4. Payments by international money order Like payments in the country through money order. The parties can resort to this method in international payment also with the help of post offices. In India, this method is of limited use as it is applicable for Nepal, Bhutan, Bangladesh and Pakistan in smaller denomination of international payments. 5. Payment through banks In present times, almost international payments are mooted through the banking system. Keeping in view the risk factor and other complexities attached in the process of making international payments. The important methods are as follows: i. Personal Cheques If debtor party has the bank account in the creditor s country, the party can make payment through issue of cheque in favour of the creditor. ii. Traveller s Cheques These cheques are issued by prominent banks and other financial institutions of international repute. It is a very convenient mode of carrying purchasing power for travelers. They are available in leading currencies of the world and in convenient denominations. The purchase of these cheques has to pay the amount of cheque with commission it also puts his specimen signatures. These cheques can be encashed at branch of issuing bank or at any other bank which has correspondent or account relationship with the issuing bank.

iii.

Banker s Cheque or Bank Draft or Demand Draft A bank cheque or bank draft is an order to pay a certain sum to a certain person or to his order issued by the bank on its foreign branch or unit s correspondent bank. This draft is handed over to the purchaser and purchaser sends it to the beneficiary by post. The beneficiary part will obtain payment on presentation to bank on which it is drawn. Mail transfer It is an instrument under which bank gives instruction to pay a certain sum to beneficiary named in the mail transfer. In this written order is sent by mail to the paying branch. There could be a time lag of one week to two weeks between the time of remittance and it is paid to the beneficiary by the paying bank. Guaranteed Mail Transfer In order to make payment within a certain time limit , the remitting party can avail the guaranteed mail transfer under which period of transit is specified and guaranteed like 5 days, 15 days , 1 month etc. there is no risk of falling into wrong hands as in the case of cheques and drafts. Telegraphic Transfer It is the speediest method of making international payments as the instructions for payment are sent by the bank by telegram, telex , cable to its branch at a foreign centre or its correspondent bank to pay a certain sum to the person named therein. In this method the beneficiary can obtain payment on the very next day of the remittance. It is costly and expensive method for the remitter as he has to bear the cable charges.TT rate is termed as the best rate in the foreign exchange market because it is the basic rate of exchange on which other rates are computed. In this method, there is no risk of loss of instrument and no risk of non-payment.

iv.

v.

vi.

vii.

Foreign Exchange Bills It is very popular and frequently used method for making international payment. A BILL OF EXCHANGE is a written unconditional order signed and addressed by the seller (exporter) to the buyer (importer) to pay to the exporter or order a certain amount on demand or at a fixed date in future. The exporter sells the bill to the bank and purchasing bank sends it to its overseas branch or its correspondent bank and it will present to person (importer) on whom it is drawn. The purchasing bank account will be credited on realization of the bill. Bill of exchange can be of two major types: a. Clean Bills b. Documentary Bills In clean bill where both parties know each other well and for long, Exporter may draw this type of bill and send all documents of title of goods directly with the bill and in documentary bill, the exporter instructs bank to deliver the documents along with the bill either against the payment of the bill or acceptance of the bill. If the documents are to be released on payment of the bill, the bill is called Documents Against Payment if the documents are to be released against the importer acceptance of the bill the bill is called as Documents Against Acceptance. The bill of exchange is also classified on the basis of time period of bill. On this basis, they can be of two types: a. Demand Bill or sight Bill b. Time Bill or Usance Bill In the case of sight bill, payment has to be made on the presentation of documents or the documents will be handed over to the importer only against payment. In a usance bill, documents are handed over against acceptance of the bill. A usance bill involves extension of credit by exporter. Thus, there is time a time gap between shipment of goods and receipt of payment. In case of urgency, an exporter may seek loan from the bank against the security of the bill or he may sell the bill at a discount.

The bill of exchange can also be termed as short bills and long bills. A SHORT BILL is one which has only a few days to run to maturity irrespective of the original period of the bill whereas LONG BILL refers to a bill having a time of at least 3 months. There are some other types of bills like: i. ii. iii. Bank Bill Trade Bill Finance or Accommodation Bill

A BANK BILL is the one which is drawn on or accepted by a bank .Such a bill carries little risk and it can be discounted at the finest or lowest rate. Bills drawn and accepted by commercial firms are know n as TRADE BILL. FINANCE BILLS are those drawn as a means enabling the drawer to raise funds. If person or firm lends his or its name as drawer and acceptor of the bill so that the drawer can raise funds by discounting the bill. viii. Letters Of Credit Letters of a credit is a more secured and fool proof method of making payments in comparison to foreign bills of exchange. As it gives security to both the parties exporter as well importer, the exporter is certain that he will receive payment once the shipment of goods takes place. Like the importer is also safe that payment will not be made unless the terms and conditions for supplying goods are complied with by the exporter hence it has becomes the most important and standard method of making international payments particularly in the field of international trade. A letter of credit is a letter containing a set of instructions given by the importers to his bank and conveyed by it to the exporter either directly or through a bank in exporter country

10. Financial Institutions

There are number of financial institutions and banks not only in the country but throughout the world which provide finance to the exporters and importers . Some of the main Financial institutions are as follows :-

1.) Authorised Dealers in Foreign Exchange The substantial portion of actual dealings in foreign exchange or the provisions of export finance and import finance to exporters and importers is dealt with by such banks in India which have been authorized by the reserve bank of India such banks are called Authorised Dealers in foreign exchange. Section 2 (c) of FEMA states that authorised person means an authorised dealer , money changer , off shore banking units or any other person authorised U/S 10 (1) to deal in foreign exchange and foreign securities . These are authorised by Reserve Bank of India under section 10 of FEMA to deal in foreign exchange. Generally, all nationalised commercial banks, leading private commercial banks and many foreign banks are appointed as Authorised Dealers to deal in foreign exchange .These dealers can deal in all transactions in foreign exchange like financing of exports and imports, facilitating in making international payment through various methods like letter of credit , foreign bills of exchange, drafts and cheques etc. drawn in foreign currency against rupee. These dealers should comply with the directions and instructions of the reserve bank given from time to time.

2.) Foreign Exchange Dealers Association of India (FEDAI)

It was established in 1958 as an All- India Association of all authorised dealers working in India. Some banks in list of authorised dealers are the members of

FEDAI. It has it headquarters in Mumbai and local offices at Banglore, Kolkata, Chennai and New Delhi. The Principal functions of FEDAI are i. To frame rules for the conduct of foreign exchange business in India within the framework of FEMA and RBI directions. ii. To co-ordinate with RBI in prior administration of exchange control. iii. To circulate information to the members and act as a clearing house for exchange of information among members. The FEDAI is a vital link between the authorised dealers and RBI. It is the mouthpiece of the authorised dealers representing their views to the RBI and other international agencies like international chamber of commerce.

3.) The Reserve bank of India

The Reserve Bank of India has the top authority to administer all matters related with export and import finance in India. Under FEMA the Reserve Bank has been given wide powers of control and regulation of foreign exchange in India. The RBI is performing a positive role in the field of international finance particularly for promoting export. It has liberalised several schemes in order to enhance facilities and schemes available for export finance.

4.) EXIM Bank

The Export Import Bank of India (EXIM Bank) was established in 1982 by the government of India as an apex body in the field of export and import finance. It is the principal financial institution engaged in financing export and import. The EXIM bank is also empowered to finance export of consultancy and related services, assist Indian joint ventures in third countries, conduct export market studies finance export oriented industries and provide international merchant banking services. EXIM bank concentrates on medium and long term

financing and refinancing and leaving the short-term financing to the authorised dealers the commercial banks.

5.) Export Credit Guarantee Corporation (ECGC)

For promoting export, for minimizing the risk and for facilitating the flow of finance from the banks to exporters, Govt. of India established another important institution Export Credit Guarantee Corporation of India Ltd. in 1964. The ECGC provides several schemes like risk policies for exporters, guarantees for banks and various standard and specific policies to protect the interest of exporters.