DETERMINATION OF FOREIGN EXCHANGE

FOREIGN EXCHANGE RATE

It refers to the rate at which one currency is for the other.. 1! Rs."#

Currency $e%reciation&it refers to $ecrease in the 'a(ue of $o)estic currency. It
)eans the $o)estic currency *eco)es (ess 'a(ua*(e+ )ore of it is re,uire$ to *uy the
forei-n currency. In$ian ru%ee is sai$ to *e $e%reciatin- if the %rice of $o((ar rises
fro) rs../ to rs."#0
Currency a%%reciation refers to increase in the 'a(ue of $o)estic currency in ter)s
of forei-n currency+i.e.+$o)estic currency *eco)es )ore 'a(ua*(e an$ (ess of it is
re,uire$ to *uy the forei-n currency. In$ian ru%ee a%%reciates when %rice of 1
fa((s fro) rs."/ to "#..
There are . ty%es of e1chan-e rate syste)s2&
Fi1e$ e1chan-e rate syste)
F(e1i*(e or f(oatin- e1chan-e rate syste)
Mana-e$ f(oatin- e1chan-e rate syste)
Fi1e$ e1chan-e rate syste)3it refers to the syste) in which rate of e1chan-e for a
currency is fi1e$ *y the -o't. either in ter)s of -o($ or si('er or in ter)s of any
other country4s currency. The )ain %ur%ose of a$o%tin- this syste) was to ensure
sta*i(ity in forei-n tra$e an$ ca%ita( )o'e)ents.
Currency $e'a(uation3it refers to re$uction in the 'a(ue of $o)estic currency *y
the -o't.
Currency re'a(uation3it refers to increase in the 'a(ue of $o)estic currency *y
the -o't.
The $iff. *5w currency $e%. an$ currency $e'a(uation is that in for)er case
e1chan-e rate is $eter)ine$ *y the )ar6et an$ in the (atter case the e1chan-e rate
is $eter)ine$ *y the -o't.
F(e1i*(e e1chan-e rate syste) 7it refers to a syste) in which the e1chan-e rate is
$eter)ine$ *y the forces of $e)an$ an$ su%%(y of $ifferent countries in the forei-n
e1chan-e )ar6et.
Mana-e$ f(oatin- e1chan-e rate syste)3in this syste) forei-n e1chan-e is
$eter)ine$ *y the )ar6et forces an$ the centra( *an6 is a 6ey %artici%ant to
sta*i(i8e the currency in the case of e1tre)e a%%reciation or $e%. . . Hence it4s a
hy*ri$ of fi1e$ an$ f(e1i*(e e1chan-e rate syste).
Deter)ination of forei-n e1chan-e rate syste)2&
E1chan-e rate -ets $eter)ine$ *y the interaction of $e)an$ an$ su%%(y of forei-n
e1chan-e.
De)an$ or outf(ow of forei-n e1chan-e arises $ue to the fo((owin- reasons2&
I)%ort of -oo$s an$ ser'ices
9hen In$ian tourists -o a*roa$5to un$erta6e forei-n tours *y In$ians.
:y )a6in- uni(atera( transfers
For %urchase of assets a*roa$
For s%ecu(ation %ur%oses
There e1ist an in'erse re(ationshi% *5w $e)an$ for forei-n e1chan-e an$ its %rice.
The $e)an$ cur'e is $ownwar$ s(o%in-.
;u%%(y or inf(ow of forei-n e1chan-e co)es fro) fo((owin- sources2&
E1%ort of -oo$s an$ ser'ices
Tourists fro) a*roa$5forei-n in'est)ents in In$ia *y forei-ners.
<ni(atera( transfers5re)in$ers fro) a*roa$
;%ecu(ation %ur%oses
There e1ist a $irect re(ationshi% *5w su%%(y of forei-n currency an$ its %rice.
;u%%(y cur'e is u%war$ s(o%in-.
:A=ANCE OF >A?MENT;
Its an accountin- state)ent that %ro'i$es a syste)atic recor$ of a(( the econo)ic
transactions *5w the resi$ents of a country an$ rest of the wor($ in -i'en %erio$ of
ti)e.
Econo)ic transactions are c(assifie$ as2&
@isi*(e -oo$s3it inc(u$es %hysica( -oo$s which are e1%orte$ A i)%orte$+ such
ite)s are seen+ touche$ A )easure$.
In'isi*(e -oo$s3these refer to the ser'ices (i6e shi%%in-+ *an6in-+ insurance..
<ni(atera( transfers3these inc(u$e -ifts+ %ersona( e))itances A other one way
transactions
Ca%ita( transfers3these re(ate to ca%ita( recei%ts throu-h *orrowin- or sa(e of
assets+ throu-h ca%ita( %ay)ent A %urchase of assets.
A(( inf(ows of forei-n e1chan-e are recor$e$ on cre$it si$e A a(( outf(ows are
recor$e$ on $e*it si$e. :a(ance of %ay)ents is )aintaine$ on $ou*(e entry *oo6
6ee%in- syste). Hence in accountin- sense+ cre$it A $e*it si$e has to *e e,ua( *ut in
econo)ic sense+ *a(ance of %ay)ent nee$ not to *e a(ways e,ua(.
:A=ANCE OF TRADE
It refers to the $iff. *5w the a)ount of e1%orts an$ i)%orts of 'isi*(e -oo$s on(y.
E1%orts are entere$ as cre$it or %ositi'e ite) whereas i)%orts are a(ways treate$ as
$e*it or ne-ati'e ite). :a(ance of tra$e is a %art of *a(. of %ay)ents.
Co)%onents of *a(ance of %ay)ents
A(( transactions enterin- the *a(ance of %ay)ent are cate-ori8e$ into current a5c
an$ ca%ita( a5c.
Current a5c3it refers to an a5c which recor$s a(( the transactions re(atin- to
e1%orts A i)%orts of -oo$s A ser'ices A uni(atera( transfers $urin- a -i'en %erio$
of ti)e.
Ca%ita( a5c3it recor$s a(( the transactions *5w the resi$ents of a country A rest of
the wor($ which causes a chan-e in the assets A (ia*i(ities of the resi$ents of the
country.
Ca%ita( a5c inc(u$es2&&
>'t. Transactions2&&it inc(u$es short ter) A (on- ter) forei-n (oans.
Recei%ts&Cr
Re%ay)ent&Dr
Officia( transactions3it inc(u$es transactions un$erta6en *y the -o't. with the
rest of the wor($B*orrowin-s fro) IMF+ wor($ *an6 etc.C
Recei%ts&Cr
Re%ay)ents&Dr
Forei-n $irect in'est)ent3%urchase of assets in rest of the wor($ such that it
-i'es $irect contro( to the %urchase o'er asset ac,uisition forei-n fir) *y an In$ian
fir).
>ort&fo(io in'est)ent3it refers to the %urchase of any asset in the rest of the
wor($ in such a )anner that it $oes not -i'e the %urchaser any $irect contro( o'er
the asset.
E1.3%urchase of shares of a forei-n fir) *y a In$ian fir)
A<TONOMO<; A ACCOMODATING ITEM;
Autono)ous ite)s refers to those internationa( econo)ic transactions which ta6e
%(ace $ue to so)e econo)ic )oti'e (i6e %rofit )a1i)i8ation+ such transactions are
in$e%en$ent of the state of *a(. of %ay)ent a5c. these ite)s are a(so 6nown as a*o'e
the (ine ite)s. Autono)ous transactions ta6e %(ace on *oth current an$ ca%ita(
a5c4s.+ on the current a5c )erchan$ise$ e1%orts an$ i)%orts of -oo$s are
autono)ous transactions whereas on the ca%ita( a5c+ recei%ts A %ay)ents of (on-
ter) (oans *y in$i'i$ua(s are autono)ous transactions.
Acco))o$atin- ite)s refers to the transactions that are un$erta6en in or$er to
)aintain the *a(ance in *a(. of %ay)ent a5c. These are co)%ensatin- ca%ita(
transactions which are )eant to the $ise,ui(i*riu) in autono)ous ite)s of *a(. of
%ay)ents. These are a(so 6nown as *e(ow the (ine ite)s. If there is current a5c
$eficit+ then the $eficit is sett(e$ *y ca%ita( inf(ow fro) a*roa$. Genera((y+ the
sources use$ to )eet the $eficit are forei-n e1chan-e reser'es or *orrowin-s fro)
IMF etc. If there is $ise,ui(i*riu) in *a(ance of %ay)ents+ it (ea$s to (ow econo)ic
cre$i*i(ity+ $ecrease in forei-n e1chan-e reser'es A (ow rate of econo)ic
$e'e(o%)ent000..