EDEN IAS

FOREIGN EXCHANGE MARKET| GS ARTICLES

The market where different currencies can be bought and sold is called theforeign exchange market.Out of the trades in different currencies, theexchange rate of the currency is determined by the economy.This is aninstitutional framework for the exchange of one national currency foranother.This is particularly correct either in the case of a free floatexchange (i.e., floating currency) regime or is a managed or hybrid exchangerate system. It is altogether not allowed either in a fixed currency system or a

hard fix (in a hard fix this happens once the currency to which the hard fixhas been done itself starts fluctuating).

EXCHANGE RATE IN INDIA

Indian currency, the ‘rupee’, was historically linked with the British PoundSterling till 1948 which was fixed as far back as 1928. Once the IMF cameup, India shifted to the fixed currency system committed to maintain rupee’sexternal value (i.e., exchange rate) in terms of gold or the US ($ Dollar). In1948, Rs. 3.30 was fixed equivalent to US $ 1.

In September 1975, India delinked rupee from the British Pound and theRBI started determining rupee’s exchange rate with respect to the exchangerate movements of the basket of world currencies (£, $, ¥, DM, Fr.). This wasan arrangement between the fixed and the floating currency regimes.

In 1992–93 financial year, India moved to the floating currency regimewith its own method which is known as the ‘dual exchange rate’.There aretwo exchange rates for rupee, one is the ‘official rate’ and the other is the‘market rate’. Here the point should be noted that it is the everyday’schanging market-based exchange rate of rupee which affects the officialexchange rate and not the other way round. But the RBI may intervene in theforex market via the demand and supply of rupee or the foreign currencies.

Another point which should be kept in mind is that none of the economieshave till date followed an ideal free-floating exchange rate. They requiresome mechanism to intervene in the foreign exchange market because this isa highly speculative market.

TRADE BALANCE

The monetary difference of the total export and import of an economy in onefinancial year is called trade balance. It might be positive or negative, knownto be either favourable or unfavourable, respectively to the economy.

TRADE POLICY

Broadly speaking, the economic policy which regulates the export-importactivities of any economy is known as the trade policy. It is also called theforeign trade policy or the Exim Policy. This policy needs regularmodifications depending upon the economic policies of the economies of theworld or the trading partners.

DEPRECIATION

This term is used to mean two different things. In foreign exchange market, itis a situation when domestic currency loses its value in front of a foreigncurrency if it is market-driven. It means depreciation in a currency can onlytake place if the economy follows the floating exchange rate system.

In domestic economy, depreciation means an asset losing its value due toeither its use, wear and tear or due to other economic reasons. Depreciationhere means wear and tear. This is also known as capital consumption. Everyeconomy has an official annual rate for different assets at which fixed assetsare considered depreciating.

DEVALUATION

In the foreign exchange market when exchange rate of a domestic currency iscut down by its government against any foreign currency, it is calleddevaluation. It means official depreciation is devaluation.

REVALUATION

A term used in foreign exchange market which means a governmentincreasing the exchange rate of its currency against any foreign currency. It isofficial appreciation.

APPRECIATION

In foreign exchange market, if a free-floating domestic currency increases itsvalue against the value of a foreign currency, it is appreciation. In domesticeconomy, if a fixed asset has seen increase in its value it is also known asappreciation. Appreciation rates for different assets are not fixed by anygovernment as they depend upon many factors which are unseen.

 

 

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