College Name: Mithibai College

Academic Year: 2021-22

Group no. - 5

Semester: 6

Subject: Indian Economy

Topic: Role of Central Bank in Foreign Exchange Rate Management

Name Division and SAP No. Sub-topic Contact No.

Roll No.
Mohit A041 40311190829
Choudhary
Aditya A042 40311190905 Foreign 8909915555
Chouhan Exchange Rate
Policy
Umair Dalwai A043 40311190128 Advantages 7715803608
And
Disadvantages
of Foreign
Exchange
Markets
Sagar Dedhia A044 40311190136
Kanishka A045 40311190138 Foreign
Desai Exchange
market and its
participants
Nisarg Desai A046 40311190139 Introduction of 8735831301
the topic
Rushang Desai A047 40311190140 Foreign 9624366227
Exchange and
factors
affecting it
Rahul A048 40311190145 Types of 7045851170
Dhabalia Foreign
Exchange
 Chirag Dhoot A049 40311190149 Conclusion 800570733
Snehashree A050 40311190153 Role of Central
Divecha and FERA,
FEMA

Name: Aditya Suresh Chouhan

Roll No.: 42

Sap ID: 40311190905

FOREIGN EXCHANGE RATE POLICY

Exchange rate policy involves choosing an exchange rate system and determining the particular
rate at which foreign exchange transactions will take place. A country’s exchange rate policy
affects its relative price structure in domestic currency terms between goods which are traded
internationally (tradeable) and goods which are produced for the domestic market (non–tradeable
or home goods). Moreover, exchange rate policy will affect the overall level of domestic prices.
For these reasons, the particular exchange rate system and exchange rate level selected will have
a widespread impact, in terms of price incentives, on the entire economy. A country’s economic
structure and its institutional characteristics are important considerations in determining
exchange rate policy
Evolution of India’s Exchange Rate Policy
Since Independence, the exchange rate system in India has transited from a fixed exchange rate
regime where the Indian rupee was pegged to the pound sterling on account of historic links with
Britain to a basket-peg during the 1970s and 1980s and eventually to the present form of market-
determined exchange rate regime since March 1993.
Liberalised Exchange Rate Management System: The finance minister announced the
liberalised exchange rate management system (LERMS) in the Budget for 1992- 93. This system
introduced partial convertibility of rupee. Under this system, a dual exchange rate was fixed
under which 40 per cent of foreign exchange earnings were to be surrendered at the official
exchange rate while the remaining 60 per cent were to be converted at a market-determined rate.
Types of foreign Exchange Market in India:
A. Spot market: It refers to a market in which the sale and purchase of foreign currency are
settled within two days of the deal. The spot sale and purchase of foreign exchange make the
spot market. The rate at which the foreign currency is bought and sold is called spot exchange
rate. For all practical purposes, spot rate is treated as the current exchange rate.
B. Forward Market: It refers to that market, which deals in the sale and purchase of foreign
currency at some future date at a pre-settled exchange rate. When buyers and sellers enter an
agreement to buy and sell a foreign currency after 90 days of the deal, it is called forward
transaction. The exchange rate settled between buyer and seller for forward sale and purchase of
currency is called forward exchange rate.
Role of RBI in Exchange Rate Policy 
The Reserve Bank of India is responsible for administration of the Foreign Exchange
Management Act,1999 and regulates the market by issuing licences to banks and other select
institutions to act as Authorised Dealers in foreign exchange. The Foreign Exchange Department
(FED) is responsible for the regulation and development of the market. On a given day, the
foreign exchange rate reflects the demand for and supply of foreign exchange arising from trade
and capital transactions. 

Name: Umair Dalwai

Roll No: 43

Sap Id: 40311190128

Advantages And Disadvantages of Foreign Exchange Market

Advantages:

Flexibility: Forex exchange markets provide traders with a lot of flexibility.

Trading Option: Forex markets provide traders with a wide variety of trading options. Traders
can trade in hundreds of currency pairs.

Transaction Costs: Forex market provides an environment with low transaction costs as
compared to other markets.

Leverage: Forex markets provide the most leverage amongst all financial asset markets. The
arrangements in the Forex markets provide investors to lever their original investment by as
many as 20 to 30 times and trade in the market! This magnifies both profits and gains.

Disadvantages:
Counterparty Risks: Forex market is an international market. Therefore, regulation of the Forex
market is a difficult issue because it pertains to the sovereignty of the currencies of many
countries.
Leverage Risks: Forex markets provide the maximum leverage. The word leverage
automatically implies risk and a gearing ratio of 20 to 30 times implies a lot of risk.

Operational Risks: Forex trading operations are difficult to manage operationally. This is
because the Forex market works all the time whereas humans do not.

Name: Kanishka Manoj Desai

Roll No : 045

Sap id : 40311190138

The Foreign Exchange Market and its Participants

Participants in Foreign exchange market can be categorized into five major groups, viz.;
commercial banks, Foreign exchange brokers, Central bank, MNCs and Individuals and Small
businesses.

1.Central banks: Important player in the foreign market is Central bank of the various countries.
Central banks frequently intervene in the market to maintain the exchange rates of their
currencies within a desired range and to smooth fluctuations within that range.

2.Foreign Exchange Broker: Foreign exchange brokers also operate in the international
currency market. They act as agents who facilitate trading between dealers. They actively and
constantly monitor exchange rates offered by the major international banks through
computerized systems such as Reuters.

3. MNCs: MNCs they exchange cash flows associated with their multinational operations.

4.Individuals and Small Businesses: Individuals and small businesses also use foreign
exchange market to facilitate execution of commercial or investment transactions. The foreign
needs of these players are usually small and account for only a fraction of all foreign exchange
transactions.
5.Commercial Banks: These banks serve their retail clients, the bank customers, in conducting
foreign commerce or making international investment in financial assets that require foreign
exchange

6.Sovereign fund: Norway-Government Pension Fund, China Investment Corporation, ADIA-

Abu Dhabi Investment Authority, etc, public investment funds that invest proceeds from
business privatizations, natural resources (oil, gas), etc, in foreign currency assets.

Name: Nisarg Mehul Desai

Roll No: 046

Sap Id: 40311190139

Introduction:

The earliest exchange rate system was popularly known as Gold Standard which existed during
1879-1934. In this exchange rate system, the value of currencies of different countries were fixed
in terms of gold. Hence under the Gold Standard exchange rate system there could be only fixed
exchange rates. After the end of World War II to 1971, another fixed exchange rate system
known as Bretton Woods System prevailed. After 1971, the exchange rate system was not purely
flexible; hence it was called Managed Float System.

A central bank, reserve bank, or monetary authority is an institution that manages the currency
and monetary policy of a state or formal monetary union, and oversees their commercial banking
system. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the
monetary base. Most central banks also have supervisory and regulatory powers to ensure the
stability of member institutions, to prevent bank runs, and to discourage reckless or fraudulent
behavior by member banks. Central banks in most developed nations are institutionally
independent from political interference. Still, limited control by the executive and legislative
bodies exists.
Name : Rushang Piyush Desai

Roll No : 047

Sap id : 40311190140

"The rate at which one country's currency may be translated into another" is how the exchange
rate is defined.

Factors affecting Foreign Exchange Rate are as follows :-

1. Inflation Rates
Changes in market inflation have an impact on currency exchange rates. If a country's
inflation rate is lower than that of another, its currency will increase in value.
2. Interest Rates
Changes in interest rates affect the value of a currency and the value of the dollar.
Interest rates, currency exchange rates, and inflation rates are all interconnected.
Increased interest rates attract more foreign capital and cause exchange rates to rise,
causing a country's currency to gain.
3. Current Account Balance
It is thought to be the most comprehensive indicator of a country's cross-border trade.
A positive current account balance means a country lends more to its trading
partners than it borrows, whereas a negative current account balance means
the country borrows more from its trade partners.
 4. Monetary policy and economic performance
Investors are more likely to seek out countries with a history of excellent economic
success and sound monetary policy. The demand for and value of the country's
currency will surely rise as a result of this.

Conclusion :- The real return on a portfolio is determined by the exchange rate of the
currency in which the majority of its investments are held. The buying power of income and
capital gains received from any returns is obviously reduced while the exchange rate is falling.

Name: Rahul .M. Dhabalia

Roll No.: 48

Sap ID: 40311190145

Types Of Foreign Exchange Rate:

1. Fixed Exchange Rate System (or Pegged Exchange Rate System).:

Fixed exchange rate system refers to a system in which exchange rate for a currency is fixed by
the government.

The basic purpose of adopting this system is to ensure stability in foreign trade and capital
movements. To achieve stability, government undertakes to buy foreign currency when the
exchange rate becomes weaker and sell foreign currency when the rate of exchange gets
stronger. For this, government has to maintain large reserves of foreign currencies to maintain
the exchange rate at the level fixed by it.

2. Flexible Exchange Rate System (or Floating Exchange Rate System).:

Flexible exchange rate system refers to a system in which exchange rate is determined by forces
of demand and supply of different currencies in the foreign exchange market.

The value of currency is allowed to fluctuate freely according to changes in demand and supply
of foreign exchange. There is no official (Government) intervention in the foreign exchange
market. Flexible exchange rate is also known as ‘Floating Exchange Rate’.
3. Managed Floating Rate System:
It refers to a system in foreign exchange rate is determined by market forces and the central bank
influences the exchange rate through intervention in the foreign exchange rate. This system is
based on the par value concept under IMF guidelines. Traditionally, International monetary
economists focused their attention on the framework of either Fixed or a Flexible exchange rate
system. With the end of Bretton Woods’s system, many countries have adopted the method of
Managed Floating Exchange Rates.

Name: Chirag Dhoot

Roll No.: 49

Sap ID: 40311190149

CONCLUSION

The Indian foreign exchange market has operated in a liberalised environment for more than a
decade. A cautious and well-calibrated approach was followed while liberalising the foreign
exchange market with an emphasis on the need to safeguard against potential financial instability
that could arise due to excessive speculation. The focus was on gradually dismantling controls
and providing an enabling environment to all entities engaged in external transactions. The
approach to liberalisation adopted by the Reserve Bank has been characterised by greater
transparency, data monitoring and information dissemination and to move away from micro
management of foreign exchange transactions to macro management of foreign exchange flows.
The emphasis has been to ensure that procedural formalities are minimised so that individuals are
able to conduct hassle free current account transactions and exporters and other users of the
market are able to concentrate on their core activities rather than engage in avoidable paper
work. With a view to maintaining the integrity of the market, strong know- your-customer
(KYC)/anti-money laundering (AML) guidelines have also been put in place.

Banks have been given significant autonomy to undertake foreign exchange operations. In order
to deepen the foreign exchange market, several products have been introduced and new players
have been allowed to enter the market. Full convertibility on the current account and extensive
liberalisation of the capital account have resulted in large increase in transactions in foreign
currency. These have also enabled the corporates to hedge various types of risks associated with
foreign currency transactions. The impact of these reform initiatives is clearly discernible in
terms of depth and efficiency of the market.

Exchange rate regimes do influence the regulatory framework when it comes to the issue of
providing operational freedom to market participants in respect of their foreign exchange market
operations. Notwithstanding a move towards greater exchange rate flexibility by most EMEs,
almost all central banks in EMEs actively participate in their foreign exchange markets to
maintain orderly conditions. While the use of risk management instruments is encouraged by
many emerging markets for hedging genuine exposures linked to real and financial flows, their
overall approach towards risk management has remained cautious with an emphasis on the need
to safeguard against potential financial instability arising due to excessive speculation in the
foreign exchange market.

In the coming years, the challenge for the Reserve Bank would be to further build up on the
strength of the foreign exchange market and carry forward the reform initiatives, while
simultaneously