Bhushan Bhatia Sr Faculty Punjab National Bank Regional Staff College Panchkula-134106 09876756600 bhushan301@yahoo.co.in Forex Markets in India History Before First World War most central banks supported currencies with gold. Even though banknotes always could be exchanged for gold, in reality this did not happen that often, developing an understanding that full reserves are not really needed. Sometimes huge supply of banknotes without gold support led to giant inflation and hence political instability. To protect national interests foreign exchange controls were introduced to demand more responsibility from market players. Closer to the end of World War II, the Bretton Woods agreement was signed as the initiative of the USA in July 1944. The Bretton Woods Conference rejected John Maynard Keynes suggestion for a new world reserve currency in favour of a system built on the US dollar. Other international institutions such as the IMF, the World Bank and GATT (General Agreement on Tariffs and Trade) were created in the same period as the emerging victors of WW2 searched for a way to avoid the destabilising monetary crises which led to the war. The Bretton Woods agreement resulted in a system of fixed exchange rates that partly reinstated the gold standard, fixing the US dollar at USD35/oz and fixing the other main currencies to the dollar -and was intended to be permanent. The Bretton Woods system came under increasing pressure as national economies moved in different directions during the sixties. A number of realignments kept the system alive for a long time, but eventually Bretton Woods collapsed in the early seventies following president Nixon's suspension of the gold convertibility in August 1971. The dollar was no longer suitable as the sole international currency at a time when it was under severe pressure from increasing US budget and trade deficits. The next decades have seen foreign exchange trading develop into the largest global market by far. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values. But the idea of fixed exchange rates has by no means died. The EEC (European Economic Community) introduced a new system of fixed exchange rates in 1979, the European Monetary System. This attempt to fix exchange rates met with near extinction in 1992-93, when pent-up economic pressures forced devaluations of a number of weak European currencies. Nevertheless, the quest for currency stability has continued in Europe with the renewed attempt to not only fix currencies but actually replace many of them with the Euro in 2001. The lack of sustainability in fixed foreign exchange rates gained new relevance with the events in South East Asia in the latter part of 1997, where currency after currency was devalued against the US dollar, leaving other fixed exchange rates, in particular in South America, looking very vulnerable. But while commercial companies have had to face a much more volatile currency environment in recent years, investors and financial institutions have found a new playground. The size of foreign exchange markets now dwarfs any other investment market by a large factor. It is estimated that more than USD 3,000 billion is traded every day, far more than the world's stock and bond markets combined. Forex Market Forex (Foreign Exchange) is the international financial market used for trade of world currencies. It has been working since 70s of the 20th century -from the moment when the biggest world nations decided to switch from fixed exchange rates to floating ones. Daily volume of Forex trade exceeds 4 trillion United States dollars, and this number is always growing. Main currency for Forex operations is the United States dollar (USD). Main Forex market participants: -Central banks of countries; -Commercial banks; -Investing banks; -Brokers, dealers; -Pension funds; -Insurance companies; -International corporations; -Individuals. Unlike stock exchanges, Forex market doesn't have any fixed schedule or operating hours -it's open 24 hours per day, 5 days per week from Monday to Friday, since buy/sell orders are performed by world banks any time during the day or night (some banks even work on Saturdays and Sundays). Just like any other exchange, Forex market is driven by supply and demand of a particular tool. For instance, there are buyers and sellers for "Euro vs US dollar". Exchange rates at Forex are changing constantly, and fluctuations may happen many times per second -this market is very liquid. Exchange rates are influenced by: -Economical factors (economical indicators of countries at the moment, politics of Central banks, changing interest rates, behaviour of importers and exporters, etc -Political factors (speeches of political leaders, president elections, etc); -Market participants' mood and feelings, their expectations, rumours, etc; -Force-major events (terroristic acts, accidents, catastrophes, etc). Nevertheless, Forex market is much more stable than stock exchanges -it is not subject to huge surges, even if one currency is declining, another one is improving. One of big advantages of the market is its' close relation with latest information technologies. Clients from different parts of the planet may connect to Internet and start trading. Even big banks tend to use electronic trading -it's the most common way of trading now. At this moment, Forex is at the rapid developing phase, and it's expected to grow more and more in the future. Some of the advantages of Forex market over stock markets and/or other equities include: -Traders can make profits both on declining and developing economies; -Traders can make very short-term orders -with some other markets there are certain regulations; -Thanks to retail centers like "Forex 4 You", it's much easier to join Forex market -virtually no minimum capital, quick registration, etc; -Market is not regulated; -There are no broker commissions or they are very low; -Much higher leverages are provided; -Market works non-stop 24 hours. In order to trade in Forex one has to convert currency first because there are no interesting pairs with rupees (in fact, there are pairs with rupees appearing now but they are not going to be very popular among Forex traders due to a number of factors), but in India there is no free conversion of the national currency! Luckily, RBI has been softening foreign exchange rules in recent years and now every Indian is allowed to exchange rupees for up to 200,000 USD per year without giving any justification. So one can say -voila, any Indian can trade in Forex for this amount now. But RBI guidelines say that Indian citizens cannot use this 200,000 allowance for margin calls. What is a margin call? Margin call is the amount you put on your balance at the Forex broker! So basically, you cannot transfer money for Forex trading, even though you can make transfers in general. So what are the options? Semi-legal option is to specify other reason of transfer -instead of margin call, you call it "investment in futures" or whatever. I call it semi-legal because you're going to lie, but on another side -it's not going to be possible, at least not that easy, to verify. Another, absolutely legal option is to ask a friend of yours who is either a NRI or a foreigner to transfer money for you, because they don't have these limitations. There is also a "grey" option -to use online currencies like e-gold. They are not regulated by any government, legally speaking -they don't exist. So you can use them without breaking any laws, but your government is not going to help you in case of problems with broker -you simply won't be able to prove that you had any money on account. Indian Forex Market Indian forex market is small when compared with other developed countries but with the multinationals coming up and new government policies the path of expansion is on its new heights. The Indian government has now open up new ways to trade and regulated this market as well. India has shown great rise in its forex turnover in last three years. People now feel comfortable to trade in and exit from the market. India's share in world forex market has shown growth of 0.9% last year and will grow further. It is the fastest growth of any country. The growth rates of developed countries is much lower compared with developing countries.UK and US have shown the lowest change in contribution of foreign exchange. In India people are now more aware of the kinds of trading like derivative markets, options, swapping, hedging etc. The most important characteristic of forex is the impact on various currencies by the change in one currency rates. Any economic activity in world affects the forex market immediately. Rules and Regulations Indian forex market is regulated by FEMA that is foreign exchange management act 1999. It controls, regulates and manages the activities of forex market in India. All the queries, petitions come under this. Factors The factors which influence the forex market in India are government polices and rules, tax structure, inflation rates, RBI rates and interest rates, foreign trade policies, world bank interest rates and economic growth and health. Recent Developments As far as the Indian foreign exchange market is concerned, during the last five years the sources of supply and demand have changed significantly with large transactions emanating from capital account unlike in the past when current account transactions dominated the foreign exchange market. The behaviour as well as the incentive structure of the participants who use the forex market for undertaking current account transactions differ significantly from those who use the market for capital account transactions. Therefore managing the capital account, particularly debt flows, is an important instrument in our overall macroeconomic management. In the last few years India had to address the challenge of large capital inflows and RBI had therefore taken certain measures to calibrate these flows by requiring external commercial borrowings (ECB) to be used for foreign currency expenditure. Measures to liberalise outflows for resident individuals, mutual funds, and corporates were also pursued. The global financial crisis and deleveraging have now led to reversal and /or modulation of capital flows particularly foreign institutional investor flows, ECBs and trade credit. In response to the emerging global developments, the Reserve Bank has taken a series of measures to augment forex and domestic liquidity. Some of the measures taken to augment forex liquidity are: • USD dollar swap lines of up to USD 10 billion for Indian banks with overseas branches and subsidiaries. The actual utilisation, as of January 9, 2009 is only USD 247 million. • Increasing interest rate ceilings for FCNR(B) and NRE deposits to LIBOR /SWAP rates plus 100 basis points and LIBOR /SWAP rates plus 175 basis points respectively. • ECB policy, which is an instrument of capital account management, has been liberalised to revert to the pre-May 2007 period. It may be recalled that due to large capital flows, the end use of ECB proceeds was limited to foreign currency expenditures. Further liberalisation in terms of expanding eligible borrowers and end use has also been undertaken viz: • Housing Finance Companies, registered with National Housing Bank (NHB) have been permitted to raise short-term foreign currency borrowings. • Corporates engaged in the development of integrated township, have now been permitted to avail of ECB under the approval route. (Integrated township includes housing, commercial premises, hotels, resorts, city and regional level urban infrastructure facilities, such as, roads and bridges, mass rapid transit systems and manufacture of building materials. Development of land and providing allied infrastructure form an integrated part of a township’s development. The minimum area to be developed should be 100 acres for which norms and standards are to be followed as per the local bye-laws/rules. In the absence of such bye-laws/rules, a minimum of two thousand dwelling units for about ten thousand population will need to be developed). • NBFCs, which are exclusively involved in financing of the infrastructure sector, may avail of ECBs from multilateral/regional financial institutions and Government owned development financial institutions for on-lending to the borrowers in the infrastructure sector under the Approval route. • Payment for obtaining license/permit for 3G Spectrum will be considered an eligible end -use for the purpose of ECB. • The corporates in the Hotels, Hospitals and Software sectors to avail of ECB up to USD 100 million per financial year, under the Automatic Route, for foreign currency and/or Rupee capital expenditure for permissible end-use. • Spreads on ECBs and trade credits were increased and the all-in-cost ceilings on ECBs were dispensed with under the Approval route. • Limit on overseas borrowings by banks was enhanced from 25 per cent to 50 per cent of unimpaired Tier I capital. Overseas borrowings for on-lending to exporters continue to remain outside the ceiling. • In order to enable EXIM bank to continue to offer buyers credit against lines of credit as well as preshipment and post shipment finance, The Reserve Bank has extended a line of credit of Rs 5000 crore. • EXIM Bank is also eligible to avail of swap facility up to USD 1 billion under the facility permitted for banks. • The FII limit for investment in corporate bonds has been hiked to USD 15 billion from USD 6 billion • ADs Category I & II and full-fledged money changers (FFMCs) have been permitted to accept payments made by travellers through debit/credit/pre-paid cards for travel abroad (for private visit or for any other purpose) provided -I. Know your customer (KYC)/anti-money laundering (AML) guidelines are complied with; II. sale of foreign currency/issue of foreign currency travellers’ cheques is within the limits (credit/pre-paid cards) prescribed by the bank; and III. the purchaser of foreign currency/foreign currency travellers’ cheque and the credit/debit/pre-paid card holder is one and the same person. (Earlier in October 2000, ADs were permitted to accept payment in cash up to Rs. 50,000 against sale of foreign exchange for travel abroad (for private visit or for any other purpose). Wherever the sale of foreign exchange exceeds the amount equivalent to Rs.50,000, the payment must be received only by (i) a crossed cheque drawn on the applicant’s bank account, or (ii) a crossed cheque drawn on the bank account of the firm/company sponsoring the visit of the applicant, or (iii) a banker’s cheque/pay order/demand draft). The Indian foreign exchange market has grown significantly in the last several years. The daily average turnover has gone up from about USD 5 billion per day in 1998 to more than USD 50 billion per day in 2008. There is also evidence of growing merchant turnover reflecting the huge increase in external transactions. The bid offer spreads are also narrow. The spot foreign exchange market remains the most important segment but the derivative segment has also grown. In the derivative market foreign exchange swaps account for the largest share of the total turnover of derivatives in India followed by forwards and options. Significant milestones in the development of derivatives market have been (i) Permission to banks to undertake cross currency derivative transactions subject to certain conditions (1996) (ii) Allowing corporates to undertake long term foreign currency swaps that contributed to the development of the term currency swap market (1997) (iii)Allowing dollar rupee options (2003) and (iv)Introduction of currency futures (2008). The currency swaps allowed companies with ECBs to swap their foreign currency liabilities into rupees. However, since banks could not carry open positions the risk was allowed to be transferred to any other resident corporate. Normally such risks should be taken by corporates who have natural hedge or have potential foreign exchange earnings. But often corporate assume these risks due to interest rate differentials and views on currencies. This period has also witnessed several relaxations in regulations relating to forex markets and also greater liberalisation in capital account regulations leading to greater integration with the global economy. Cash settled exchange traded currency futures have made foreign currency a separate asset class that can be traded without any underlying need or exposure and on a leveraged basis on the recognized stock exchanges with credit risks being assumed by the central counterparty. Since the commencement of trading of currency futures in all the three exchanges, the value of the trades has gone up steadily from Rs 17, 429 crores in October 2008 to Rs 45, 803 crores in December 2008. The average daily turnover in all the exchanges has also increased from Rs 871 crores to Rs 2,181 crores during the same period. The turnover in the currency futures market is in line with the international scenario, where I understand the share of futures market ranges between 2 – 3 per cent. Impact of Global Crisis on India India has been hit by the global crisis through all channels like the financial channel, the real channel and the confidence channel, As per Reserve Bank Of India, the outlook for global economic growth in 2009 had deteriorated sharply. In January, the IMF had revised its forecast of 2009 growth in purchasing parity terms to 0.5%, down from the 3.0% projection made in October 2008. Further, world trade was expected to shrink 2.8% in 2009. Table 1 : Forex Market Activity (Per Cent) April 05-Mar. 06 April 06-Mar. 07 April 07-Mar. 08 April 08-Dec. 08 Total turnover (USD billion) 4,404 6,571 12,304 9,621 Inter-bank to Merchant ratio 2.6:1 2.7:1 2.37: 1 2.66:1 Spot/Total Turnover (%) 50.5 51.9 49.7 45.9 Forward/Total Turnover (%) 19.0 17.9 19.3 21.5 Swap/Total Turnover (%) Source: RBI 30.5 30.1 31.1 32.7The main reason for India being affected by the global downturn was globalization. India’s two-way trade, that is merchandise exports plus imports, had increased to 34.7% of GDP in 2007-08, from 21.2% in 1997-98, the year of the Asian crisis. Again, the ratio of total external transactions, gross current account flows plus gross capital flows to GDP, jumped to 117.4% of GDP in 2007-08 from 46.8% in 1997-98. The corporate sector had also increased its external commercial borrowings to finance new investments. Clearly the ‘decoupling theory’, which postulated that emerging economies would remain unaffected by a downturn in the advanced economies, not least because of more than comfortable foreign exchange reserves, has not worked. Indeed, the last few months which have seen capital flow reversals, widening of spreads on sovereign and corporate debt and sharp currency depreciations, attest to both being inextricably linked “So, the reason India has been hit by the crisis, despite mitigating factors, is clearly India’s rapid and growing integration into the global economy”. The Reserve Bank’s response to the crisis was to attempt to keep the contagion of financial crisis out and to ensure that the liquidity stress did not trigger solvency problems within India. To this end, the Reserve Bank decided firstly to maintain a comfortable rupee liquidity position. The second policy response was to augment the foreign exchange position, while putting in place a policy framework to keep credit delivery on track. Another important objective was to keep economic growth going. The government had already announced a fiscal stimulus package of about $75 billion in an attempt to jump start the economy. However, economic prospects for the near future were grim, the RBI chief said. The services sector, an important engine for the recent surge in growth was faltering, with slowdowns witnessed in construction, transport, communication, trade, hotel and restaurants sectors. The bright spot was that the country’s financial markets were resilient and the banking system was sound. Position of Outward Remittances from India Indians are taking more money outside the country, legally that is. According to figures put out by the Reserve Bank of India (RBI), outward remittances by Indians climbed manifold from a mere $10 million in 2004-05 to $441 million in 2007-08. In the eight months of this fiscal, that number has once again been eclipsed and is already at $530 million. Admittedly, this is a fraction when compared to $30 billion that comes in as remittance from NRIs. But for a country that has hitherto been seen as a grabber of remittances (India is the country with the largest remittance from overseas), the change, however small, is significant — especially so, in these troubled times. India has dollar-millionaires numbering over one lakh, according to various estimates put out by private banking establishments that serve high net worth clients. It is the geographical diversification of these clients that is probably accounting for the rise in real estate as well as equity investments overseas. Of course, tourism and education are also contributing their share. RBI figures show that the money that is taken out is spent mainly (about a third) on travel, tours and education. There are about 8 million outbound tourists from India and the travel industry expects this to double to over 16 million in the next three to four years. About 1.3 lakh students go abroad for higher studies. A significant portion of outward remittance (another third) is spent on investment in equity and debt. The balance goes towards gifts, donations, deposits and purchase of immovable property. (Source RBI Report) Conclusion: The overall approach to the management of India’s foreign exchange reserves takes into account the changing composition of the balance of payments and endeavours to reflect the ‘liquidity risks’ associated with different types of flows and other requirements. As capital inflows during 2007-08 were far in excess of the normal absorptive capacity of the economy, there was substantial accretion to foreign exchange reserves by US $ 110.5 billion. The foreign exchange reserves declined by US $ 23.4 billion from US $ 309.7 billion as at end-March 2008 to US $ 286.3 billion by end-September 2008 largely reflecting valuation effects. Excluding valuation effects, the decline was US $ 2.5 billion. Between October 2008 and January 16, 2009 foreign exchange reserves declined by US $ 34.1 billion to US $ 252.2 billion, including valuation effects. However, India’s current level of foreign exchange reserves remains comfortable. ____________________________________________________________________________________ References: Keynote address by Ms. Shyamala Gopinath, Deputy Governor, Reserve Bank of India at the Annual Conference of Foreign Exchange Dealers’ Association of India (FEDAI) at Kolkata on January 10, 2009. Rbi.org.in