Personal Website of R.Kannan
Learning Circle- Banking Theory and Practice
Foreign Exchange Market in India

1. Liberalisation of trade and economic activities creating global pattern of trade and commerce
   Globalisation process has taken deep roots in the world and every country now looks to the world as the market for its product. Trade barriers are being dismantled world over and a closer integration of the world economy is taking shape

2. Revolutionary change in the composition of FEX business
   Secondly in recent years foreign exchange markets have assumed a life and momentum of their own independent of the underlying commercial transaction. Until mid-70s commercial transactions provided the raison detre for foreign exchange transactions, But today financial transactions and intra-day trading constitute more than 90-95% of daily turnover in the market.

3. With the progressive elimination of exchange and capital control and the revolutionary developments in telecommunication and computer technology, an active 24-hour trading in foreign exchange has emerged.

4. Due to instantaneous dissemination of information simultaneously to all centres around the world, exchange rates in all centres are today closely aligned.

Composition of the Indian Market

Foreign exchanged market in India is totally structured, well regulated both of RBI and also by a voluntary association (Foreign Exchange Dealers Association). Only Dealers authorised by RBI can undertake such transactions. All inter-bank dealings in the same centre must be effected through accredited brokers, who are the second arm in the market-structure. However, dealings between the authorised dealers and the RBI and also between the Ads and overseas Banks are effected directly without the intervention of the brokers.

The Market for foreign exchange in India consists of distinct segments, viz.

1. Apex segment covering transactions between the RBI and the authorized Dealers, i.e. commercial banks authorised to deal. In foreign exchange. RBI used to act as the rate setter as well as the residual partner in respect of commercial transactions. The exchange rate is now, largely, market-determined through the forces of supply and demand, a feature of the liberalisation process and growing economic stability of the country.

2. The Inter-bank market is the second segment. This segment covers the dealings of Authorised Dealers among themselves and with overseas banks.

3. The Primary Segment covering dealings of Authorized Dealers with customers, the general public, trade and commerce, who have to buy and sell currencies in the normal course of commercial business.

4. In addition to the authorised dealers covering commercial banks, who undertake comprehensive transactions covering all spheres of foreign exchange, there are also a peripheral market consisting of licensed money changers and travel agents, who enjoy limited Authorisation especially for encashment of traveler’s cheques, noted. Specified hotels and Government owned Shops are also given restricted licenses to accept payment from non-residents in foreign currencies. IDBI, and Exim Bank are permitted handle and hold foreign currencies in a restricted way.

Main Centres of Business

Mumbai is the principal centre. Other important centres are Calcutta, New Delhi, Madras, Bangalore, Cochin and Pondicherry. Until recently the various centres functioned as fragmented markets leading to wide variations in exchange rates. With the improvement in telecommunication facilities the various centres are being increasingly integrated and they are now functioning as part of a single geographically extended market. In the context of recent developments in telecommunication and computer facilities, individual market centres are just conduits and foreign exchange business can be transacted from any centre without jeopardizing efficiency.

Infrastructure facilities to the Authorized Dealers

These include Reuter Screens (displaying moment to moment changes in exchange rates, market news, interest rates, and other relevant information, updated on-going quotations for major currencies by market makers in the Indian Market against the rupee etc. Special direct telephone and voiced contact with main brokers, teleprinter, telex and electronic mail for contacts with selected overseas dealers, Banks etc. The dealing rooms of some Banks in India are comparable to the Dealing Rooms of in Overseas markets.

Exchange Rate for Merchant Transactions

Earlier foreign exchange rates for various types of merchant transactions (both spot and forward) were fixed by the Foreign Exchange Dealers Association of India (FEDAI) in consultation with RBI. Recently however this arrangement was abolished and the Individual Bank were permitted to quote competitive rates, based on the on-going inter-bank or overseas market rates. This freedom with the relaxation of some of the provisions of the exchange control gave a fillip to the growth of Indian market.

Another major change in recent years is that an active rupee-dollar segment has emerged, which is sufficiently deep enough for dealers to switch over to dollar based cross rate quotations in the market in contrast to the traditional cross rates via. the rupee-sterling rate. Thus the Indian market is progressively moving towards the international practice of quoting cross rates via the dollar

Another progressive change to take place recently is the adaptation of two-way rate quotation, leaving the earlier practice of quoting one way. Banks as well as brokers were earlier unfamiliar with the two-way quotations and the attendant accounting and dealing positions. In the recent past some of the active foreign banks and a few Indian Banks began quoting two-way rates. In the International market two-way quotations are only given. It is also accepted that the spread between the buying and selling rates, in keeping with International Market traditions, should not be more than 10 points and only in very uncertain markets it widens to 20 or points. FEDAI has drawn up a code of conduct and encouraging dealers and brokers to switch universally to two-way quotations.

However forward quotes generally in the form of Swaps (ranging from 2 days to one month are not given in India in two way quotes, but continue to be quoted one way. These swaps are frequently undertaken for adjusting in foreign currency funds position of the banks. This segment cannot develop in India due to exchange controls on fund flows between India and overseas markets. Swaps and forward rates are determined in India purely by demand and supply factors, and consequently they are subject to wide fluctuations.

Objectives of RBI Exchange control Policy

In recent years the objective of RBI is to develop an active inter-bank market in India. The advantages of this policy are:

1. It enables greater matching of sales and purchases of currencies within the country, thereby reducing operating expenses.

2. This helps competition finer rates to merchants as more and more Ads can have access to Indian Market than to Overseas Market.

3. Need to maintain larger balances abroad is reduced

Main provisions of the Exchange Control by RBI

1. ADs (Authorised Dealers) are required to maintain square or near square position in each currency, including both spot and forward transactions

2. Foreign currency balances commensurate with normal business requirements alone are permitted

3. Lending foreign currency to branches/correspondent banks or investing them abroad is not permitted.

4. Total credit or loan facilities that can be availed from branches/correspondents globally is limited to Rs.20 lakhs, any excess must be adjusted within 5 days;

5. Purchases/sales of any permitted foreign currency both spot and forward, and swaps of any foreign currency can be done against the rupee or any other currency in the inter-bank market but such transactions should not create mismatched maturities or overbought or oversold position at the end of the day;

6. Spot purchases and sales of permitted currency against any other permitted currency (not against the rupee) can be done freely to cover genuine merchant transactions. Or for purposes of adjustment of the AD’s own position.

7. Sales of Sterling, the U.S. Dollar, Deutsche Mark and Yen by the ADs to RBI is permitted only as cover for genuine merchant transactions or to dispose of counterpart funds obtained from international markets as cover for merchant transactions. Sales to RBI of currency purchase from the inter-bank market or international markets are not permitted. RBI does not sell any currency other than pound sterling. With effect from February, 87 RBI started selling U.S. Dollars to Ads to cover their genuine merchant transactions. This facility was allowed only at Bombay.

8. As far as possible banks should seek cover in the inter-bank market. ADs could take resort to International Market only as a last resort.

Compared to the markets in the Developed countries of Europe, Japan and U.S. the foreign exchange market is small. But it is growing rapidly and has potential to emerge to the frontline position.