Determinants of foreign exchange

Determinants of Foreign Exchange

DEFINITIONS

• Foreign Exchange The system of converting one national

currency into another, or of transferring money from one country to another.

• Foreign Exchange Market Forex market is a place in which foreign

exchange transactions take place. A market in which National currencies are

bought and sold against one anotherThe foreign exchange market is one of the

largest markets in the world. By some estimates, about 3.2 trillion USD worth of currency changes hands every day.

Foreign exchange reserves

Exchange Rates

Indicative on Friday April 16, 2010

IMPORT

Currency

EXPORT

Forward Spot Spot Forward

6 months 3 months 1 month TT * Bill TT* Bill 1 month 3 months 6 months

45.26 44.85 44.58 44.42 44.46 US Dollar 44.34 44.32 44.5 44.78 45.19

61.23 60.69 60.32 60.11 60.15 Euro 60.00 59.99 60.21 60.59 61.14

69.92 69.32 68.93 68.69 68.74 Pound Sterling 68.57 68.56 68.81 69.23 69.84

48.84 48.36 48.05 47.87 47.90 Japanese Yen* 47.75 47.74 47.95 48.26 48.72

42.8 42.38 42.1 41.94 41.97 Swiss Franc 41.83 41.82 42.01 42.28 42.7

8.22 8.15 8.11 8.08 8.09 Danish Kroner 8.06 8.06 8.09 8.14 8.21

32.96 32.67 32.47 32.36 32.38 Singapore Dollar 32.29 32.28 32.42 32.61 32.91

5.84 5.78 5.75 5.72 5.73 Hong Kong Dollar 5.71 5.71 5.73 5.77 5.83

41.27 41.35 41.53 41.38 41.40 Australian Dollar 41.32 41.31 41.45 41.57 41.65

31.9 31.84 31.79 31.74 31.76 New Zealand Dollar 31.68 31.68 31.79 31.92 32.08

7.65 7.61 7.59 7.57 7.58 Norwegian Kroner 7.55 7.55 7.59 7.62 7.67

6.33 6.24 6.24 6.21 6.22 Swedish Kroner 6.20 6.20 6.22 6.26 6.32

45.07 44.73 44.47 44.31 44.34 Canadian Dollar 44.21 44.20 44.39 44.66 45.06

Source: State Bank Of India, Chennai *TT - Telegraphic Transfer

Features of Foreign Exchange Market

The foreign exchange market is unique because oftrading volume results in market liquiditygeographical dispersioncontinuous operation: 24 hours a day except

weekendsthe variety of factors that affect exchange ratesthe low margins of relative profit compared with other

markets of fixed incomethe use of leverage to enhance profit margins with

respect to account size

Participants

Individuals: tourists, migrants

Firms: importers and exporters

Banks:commercial & central banks

Governments / monetary authorities

International agencies

Functions of Forex Market

• Transfer of Purchasing power

• Provision of credit

• Provision of hedging facilities

Determinants of Foreign Exchange Market

Long – term Factors Short-term Factors

Long-term Factors

• Balance of Payments

• Strength of economy

The relative strength of an economy has effect on demand and supply of foreign currencies.

If an economy is growing at a faster rate, in the long-run, it is generally expected to have a better performance on Balance of Trade .

• Interest rate

The capital is attracted towards currencies yielding higher interest rates, providedthere is full currency convertibility in capitalaccount.

• Inflation

A higher rate of inflation will make acountry’s currency less attractive because of the loss of real value with inflation.◦ Hence, that currency would depreciateagainst major currencies.

• Money Supply

An increase in money supply will affect the exchange rate through causing inflation in thecountry. It can also affect the exchange rate directly in the short run.

• National Income

An increase in the national income will lead to an increase in investment or in consumption and accordingly, its effect on the exchangerate will change.

Short term factors

• Central bank intervention

Buying and selling of foreign currency in themarket by the Central Bank with a view to increasing the supply or demand, there by affecting the exchange rate, is known asintervention.

• Export receipts and import payments

The difference between the total receiptsfrom export bill realizations and import payments on a given day in a country determines the exchange rate to some extent.

• Foreign investment flows

Both foreign direct and portfolio investmentinflows and outflows affect the exchangerates.

• Political factors

Factors like war. Announcement of election results, oil price increase etc will causeexchange rate fluctuations.

• Speculation

If a few big speculators start buying a currency in an aggressive manner, others may follow suit. Thus, the demand of the currencymay increase.

• Capital Movements

Movement will be caused by externalborrowings and assistance. Large-scale external borrowing will have favorable effect on the exchange rate of the country’s currency.

FEMA• The Foreign Exchange Management Act or in short FEMA has been introduced as a

replacement for earlier Foreign Exchange Regulation Act (FERA). FEMA came into act on the 1st day of June, 2000.

The main objective behind the Foreign Exchange Management Act (1999) is to consolidate and amend the law relating to foreign exchange with objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India.

FEMA is applicable to the all parts of India. The act is also applicable to all branches, offices and agencies outside India owned or controlled by a person who is resident of India.

FEMA head-office also known as Enforcement Directorate is situated in New Delhi and is headed by a Director. The Directorate is further divided into 5 zonal offices at Delhi, Bombay, Calcutta, Madras and Jalandhar and each office is headed by a Deputy Directors. Each zone is further divided into 7 sub-zonal offices headed by the Assistant Directors and 5 field units headed by the Chief Enforcement Officers

Conclusion• Liquid Investment- foreign exchange market has the advantage of being extremely

liquid. What this means is that investors would be able to withdraw from their investments at any point in time relatively easily.

This is due to the fact that the foreign exchange market has a global market, which means searching for a buyer to purchase a particular currency which you are interested to sell is usually not a big problem.

• Convenience-foreign currency exchange trading is extremely convenient. Organized as an over-the-counter market, foreign exchange traders from all over the world are brought into contact each day via the internet. This means that traders would be able to trade with one another 24 hours a day, five days a week.

• FACILITATES TRADE AND DEVELOPMENT