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India's Foreign Exchange System: An Analysis

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2.1 Introduction:

It is a fact that the currencies of different countries have different values that is based upon their actual economic and monetary strength. It is from this difference that the genesis of foreign exchange occurs.

Foreign exchange can be termed as the act of matching the different values of the goods and services that is involved in the international business transaction process in order to attain the exact value that is to be transferred between the parties of an international trading transaction in monetary terms.

Foreign exchange as an activity had started the day civilization and independent principalities got established in the world. But in those days it was a case of exchanging value in the form of transfer of goods and services of identical value that is commonly identified with barter system. Moreover the transactions were done on a one-to-one basis, and the terms and conditions were determined by the parties entering into such transactions. There was no universal system or rule that determined these transactions. In that way foreign exchange and international monetary system is a modern day trend that gained an institutional form in the first half of the twentieth century and has been developing since then.

2.2 Foreign Exchange:

According to International Monetary Fund (IMF), Foreign Exchange is defined as different forms of financial instruments like foreign currency notes, deposits held in foreign banks, debt obligations of foreign banks and foreign governments, monetary gold and Special Drawing Rights (SDR) that are resorted to make payments in lieu of business transactions that is done by two business entities or otherwise, of nations that have currencies having different inherent monetary value (www.imf.org).

Leading economist Lipsey Richard G.,1993 has mentioned that the foreign exchange transactions are basically a form of negotiable instrument that are resorted to deliver the cost of goods and services that form a part of trading transactions and otherwise, between business and public entities of nations of the global economy.

Sarno, Taylor and Frankel, 2003 gives the definition of foreign exchange as denoting the act of purchase and sale of currencies of different economies that is performed over the counter for various purposes that includes international payments and deliverance of cost of various business transactions, where the value is usually measured by tallying the value of the currencies involved in the foreign exchange transaction with that of the value of U.S. Dollar.

According to Clark and Ghosh 2004, Foreign Exchange denotes transactions in international currency i.e. currencies of different economies. In such transactions the value of a currency of one country is tallied and exchanged with similar value of the currency of the country in order to exchange the cost of a business transaction or public monetary transfer that is taking place between two entities of these economies.

2.2.1 Foreign Exchange Transactions:

Transactions in foreign exchange are done through various types and various modes between different countries of the world.

According to information mentioned in the Reuter's Financial Training Series, 1999,'TOD' Transactions, 'TOM' Transactions, Swap Rates, Spot Rates, Forward Rates, Margin Trading and Buy / Sell on Fixed Rates foreign exchange transaction methods are some of the commonly used methods that are widely used by global managers for their foreign exchange transaction activities. TOD Operations:

TOD Operations are foreign exchange transaction methods where the trader uses the exchange rate of the day on which the foreign exchange transaction order is to be executed. In other words TOP operations are commonly used in intra-day foreign exchange transactions. As a result they are commonly resorted to by speculators in foreign exchange transactions and those who general speculate on the rates of different foreign exchange markets of the globe. TOM Operations:

In this type of transactions the transaction process carried forward to the next day instead of it being an intra-day trading. TOM transactions rate is fixed on the day the transaction is signed, but the rate of exchange is agreed upon to be that of the next day. SPOTTransactions:

SPOT Transactions can be compared with TOM transactions because here also the exchange rate is fixed at a value that prevails over the exchange rate of intra-day trading of shares. But SPOT transactions have been separated as a different category because unlike TOM transactions, SPOT transactions' contracts are executed on the third day after the signing of agreement between the Bank and the client. Forward Contract:

Forward contracts are those exchange rate contracts where the currency conversion exchange rate agreement is decided at a certain rate at a time that is well before the date of execution of the exchange contract. In that way they are similar to TOM transactions. The only differ from them in the fact that these transactions are made for a long term i.e. generally for one year, and the parties involved in making this foreign exchange transaction deposit five percent of the contract value with the bank involved in facilitating the transaction at the time of executing the contract which is then returned to the client after execution of the exchange transaction. The need for depositing this amount is to secure the transaction against any loss due to market fluctuations. SWAP:

The greatest advantage of SWAP transactions is that the clients involved in the foreign exchange get prior information about the exchange rate of the currencies that are part of the transaction. In this type of transaction the bank first buys the amount of transaction form the client and resells it to the client after a few days after disclosing the exchange rate of the currencies involved in the transaction process. SWAP transactions are much sought after by traders because here they get to know beforehand the exchange rate of the currencies involved in the transaction process that helps them in avoiding fluctuations in market rate and gives them the advantage of determining the prices of goods, the nature of the currency market notwithstanding. . MarginTrading:

The key element of Margin trading is that any trader can opt for SPOT trading round the clock by going through the margin trading mode. The other key element of margin trading is that the traders can make deals with a minimal spread for a huge amount of funds by projecting fraction of the needed amount. In that way it is a unique form of global financial transaction where the threshold value that can be transacted through the margin trading mode is $ 100000 with bigger deals being multiples of $ 100000. But in order to deal in margin trading the trader has to make a security deposit of five recent of the contract value that has to be replenished from time to time in order to maintain the amount from which the probable losses from margin trading transactions are accommodated. Buying/Selling on Fixed Rate Order:

This is a mutual agreement between the buyer and seller of foreign exchange. Neither its rate nor its other terms and conditions are based upon actual conditions. Rather the deal is based keeping the mutual profitability of the buyer and seller intact where both of them get their desired amount.

2.3 Global Foreign Exchange Market:

According to the table depicting the 'Triennial Bank Survey of Foreign Exchange and Derivatives Market Activity' done by Bank for International Settlements (BIS)2007, as shown below the global foreign exchange market has an average daily turnover of over $ 2 trillion, which is an increase of around forty percent in terms of volumes . This rise in foreign exchange transactions it is observed has been due to rise in the volume of trading in 'Spot' and 'Forward' markets. This is indicative towards increase in volatility of foreign exchange markets around the world. (www.bis.org).

Global Foreign Exchange Market Turnover


Daily averages in April, (in billions $)









Spot Transactions







Outright Forwards







Swaps in Foreign Exchange







Gaps in Reporting (Estimated)







Total Turnover (Traditional)







Memo: Turnover (At April 2004 Exchange Rates)







(BIS Triennial Central Bank Survey, 2004)

As observed by Jacque Laurent L.1996, Studies in foreign exchange point to the fact that the volume involved in foreign exchange transactions in the total markets around the globe has the potential to affect the overall functioning of the global financial system due to the systematic risks that are part and parcel of the foreign exchange transaction system. Most of the transactions occur in the major markets of the world with the London Exchange followed by New York and Tokyo Stock Exchange accounting for over sixty percent of the foreign exchange transactions done around the globe. Among these transactions the largest share is carried out by banks and financial institutions followed by other business transactions i.e. exchange of value for goods and services as well as dealers involved in securities and financial market transactions. According to the studies by Levi Maurice D., 2005, in foreign exchange transactions most of the transactions happen in the spot market in the realm of OTC derivative contracts. This is followed by hedging and forward contracts that are done in large numbers. The central banks of different countries of the world and the financial institutions operating in multiple markets are the main players that operate in the foreign exchange market and provide the risk exchange control mechanism to the players of the exchange market and the system where around $ 3 trillion amount of money is transacted in 300000 exchanges located around the globe. The largest amount of transactions takes place in the spot rate and that too in the liquidity market. The quotation on price in these markets sometimes reaches to around two thousand times in a single day with the maximum quotations being done in Dollar and Deutschemark with the rates fluctuating every two to three minutes with the volume of transaction for a dealer in foreign exchange i.e. both individual and companies going to the range of $ 500 million in normal times. In recent years the derivative market is also gaining popularity in OTC dealings with regards to the foreign exchange market.

2.4 Global Foreign Exchange Market Management Risks:

According to the researcher Kim S. H., 2005, Foreign exchange transactions are identified by their connection with some financial transactions occurring in some overseas market or markets. But this interconnectivity does not affect the inherent value of the currency of the country which is determined by the economic strength of that country. This means that the inherent value of each currency of the world is different and unequal. So when the need arises to exchange the value of some goods or service between countries engaged in such activity it becomes imperative to exchange the exact value of goods and services. Considering the complexity and volume of such trading and exchange activity occurring in the global market between countries it is but natural that the currencies of individual countries is subject to continual readjustment of value with the currency with which its value has to be exchanged. This gives rise to the importance of foreign exchange transactions as a separate area of study and thereby needs much focus for its understanding (Frenkel , Hommel and Rudolf , 2005). In addition to this it is to be realized that with the growing pace globalization and integration of global economic order there has been a tremendous increase in international business transactions and closer integration of economic systems of countries around the world especially between the members of WTO, that has led to the increase in economic transactions and consequent activity in international foreign currency exchange system (Adams, Mathieson and Schinasi, 1998). Added to this is the fact that the exchange value of currencies in the transactions is not determined by the respective countries but by the interplay of value of the currencies engaged in an international foreign exchange transaction and the overall value of each currency in the transaction prevailing at that time. In fact each country in the global economic order would want to determine the value of its currency to its maximum advantage, which was possible a few years ago in when the countries used to determine the value of their currency according to the existing value of their economy. The individual countries till the early nineties used to follow a policy of total or partial control over the exchange value of their currency in the global market. At the same time there also were a group of countries that followed the policy or system in determining the exchange value of their currency i.e. left it to the interplay of global economic activity where the value was determined by its economic performance. The currencies of countries that provide full or partial amount of control in the international exchange value of its currency are known to follow a 'Fixed Rate' whereas the currencies of countries that allow its currency to seek its inherent value through its performance in the global economic system are termed as following the 'Floating Rate' of foreign exchange conversion mechanism. Though logically both the type of mechanism of foreign exchange face the effect of exchange rate fluctuations and consequent volatility in rate it is the currencies having a floating rate that are continually affected by the fluctuations in exchange rate in the global market when in the case of currencies with a fixed rate it is more of a controlled and regulated affair (Chorafas Dimitris N., 1992).

2.5 Foreign Exchange Risks Prevailing in the Global Market:

Risks related to the exchange rate of a currency in the global market as has been mentioned, occurs due to the interplay of inherent value of each currency of the respective countries that are part of the global financial mechanism. Risks related to foreign exchange come into picture and are also inevitable in this world marching towards increased interaction due to globalization. The risks will occur due to business interaction and consequent exchange of value for goods and services.

According to Kodres LauraE., 1996, the risks related to foreign exchange occur when there is increased interaction between the currency of a country with that of other countries in the international market and that too if the currency has a floating exchange rate. In that case the value of the currency is continually affected by its business and financial performance. This relation with other currencies in the market affects it during the time when the need arises to exchange it with another currency for settlement of financial transaction in some business or financial purposes and gives rise to various types of risks. The prominent risks associated during this situation are Herstatt Risk, and Liquidity Risk.

2.5.1 Herstatt Risk:

Herstatt risk is a risk that is named after a German Bank that got liquidated by the German Government in the seventies of the last century and made to return all; the claims accruing to its customers. This is because its creditworthiness was affected and it could not pay the settlement claims to its customers and also on behalf of its customers to their clients. It is basically connected to the time aspect of foreign exchange value claim settlements in which the foreign exchange transactions do not get realized as the bank loses its ability to honour the transaction in the intervening period due to some causes. In the particular case the German bank failed to honour the financial settlement claims of its clients to their counter parties that were to be paid in values of U.S Dollars. The main issues that arose were regarding quantifying the amount to be delivered and the time of the transaction process due to the two countries' financial systems being located and working according to different or separate time zones. This case has established a phenomenon in foreign exchange market where there may erupt situations in which the working hours of banks located in different time zones may never match with each other leading to foreign exchange settlement transactions getting affected during the mismatch of the two banks closing and opening time. In fact the Alsopp Report that studied this phenomenon in detail said that though the foreign exchange transactions are made in pen and paper on a single day the actual transfer of value takes place within three to four days. And with the exchange value of currencies operating in the international market always remaining in a state of flux they either get jacked up or devalued. In either case it affects the clause of transactions that was decided on an intra-day rate, as the value of both the currencies in the international market has changed during these days.

2.5.2 Risks related to Liquidity:

There can crop up different problems related to the banking systems' operations and dynamics i.e. in both technical and management systems as well as inability in terms of volume of available liquidity strength or in mismatch in tallying of time etc; that can affect the capacity of banks to honour foreign exchange transactions in terms of transfer of liquidity. These types of risks are being commonly witnessed in newly emerging economies that are being unable to cope with the sudden surge in volume of global business transactions thereby leading to exchange rate settlement and payment delays, outstanding payments and dishonouring of financial commitments in the exchange rate transaction market.

2.5.3 Financial Repercussions:

According to the Studies in foreign exchange related risks by Dumas and Solnik, 1995 aver that risk related to transactions in foreign exchange have increased with globalization and the rise of global economic integration process with the countries getting affected in relation to the volume of their transactions in the global financial and business marketplace. This is because the market is now more oriented towards market value driven convertibility of currencies that is influenced by the global financial movements and transactions, and any independent transaction especially of transnational and multinational companies; will automatically affect other transactions happening in the global financial marketplace (Klopfenstein G.,1997).

However, according to another study by Gallati Reto R., 2003, these multinational and transnational companies are simultaneously being affected by the fluctuations in exchange rate of different currencies of the global market that is exposing their business operations in different global markets to exchange rate related risks especially due to difference in 'Spot' and 'Forward' rates and the inevitable fluctuations (Choi , 2003) that give rise to foreign exchange settlement related problems.

2.5.4 Remedies to Foreign Exchange Settlement Risks:

As there risks that have cropped up in foreign exchange transactions due to increase in volume and frequency of transactions mainly as a result of globalization so, also there have come up remedies to minimize the risk related to adverse conditions in foreign exchange transactions.

The Bank for International Settlements (BIS) in one of its studies in 1999 has said that settlement of claims is the most predominant risk that is related to foreign exchange transactions, especially the speed with which these transactions are materialized and the roadblocks that they may face in the process due to tremendous increase in volume of foreign exchange transactions that cannot be cleared in expected times. The solution to these risks according to the study is to simultaneously clear transactions on either side i.e. for both the parties' side so that they simultaneously give and receive payments at the agreed rate of exchange. This would solve the problem of extended time of actual payment when the rate of exchange fluctuates, thereby creating problems for both the parties. This arrangement is related to deals being processed simultaneously, which requires the concurrence and common cause of both the parties. This is because the party that is expecting a hike in value of its currency may not agree to such a proposal. In that case there should be some law or arrangement that would make it mandatory for both the parties to settle their intra-day payments on that day itself so that there is no scope left for speculation by them. According to the study, such arrangements have been made in USA and Europe where systems like 'Fedwire' and 'Trans- European Automated Real-Time Gross Settlement Express Transfer (TARGET)' have been established. 'Fedwire' facilitates payments in foreign exchange transactions under the mode of 'Real Time Gross Settlements (RTGS)'and 'TARGET' facilitates intra-day transfer of foreign exchange between parties of member countries of Europe on the same day itself.

But, for simultaneous release of funds by both the parties and the intra-day settlement of claims to succeed it is imperative that the member countries of the global economic system should come together have concurrence on these issues. This is because all said and done the foreign exchange transaction related rules and laws are still governed by the respective countries. And most of these countries are reluctant to make any headway in linking their currency system to the global currency system for speedy disposal of foreign exchange transactions for fear that such a move would expose their currency end financial system to the baneful effects of risks and volatility of global foreign exchange system (Hagelin and Pramborg, 2004).

At the level of international trading corporations there has been initiated some steps whereby they have formed a private arrangement known as 'Group of Twenty'. They are a group of twenty internationally acclaimed global clearing banks who have formed an system called the 'Global Clearing Bank' that acts as a connection between the payment systems of different countries and verifies international foreign exchange transactions in order to simultaneously satisfy both the parties regarding authenticity of the process of transaction. The thing is that this system puts a high amount of strain on the financial and foreign exchange system as well as reserves of individual countries along with requiring them to bring about some amount of commonality between the financial rules and regulations of individual countries which is easier said than done. All the same the establishment of 'Bilateral Netting System' and 'Multilateral Netting Systems' as well as of 'Exchange Clearing House (ECHO)' are trying to facilitate foreign exchange transactions and minimize the inherent risks involved (McDonough ,1996).

2.6 Indian Foreign Exchange System:

2.6.1 Historical Background:

The historical background of foreign exchange system in India was a saga of excess control and monitoring with even minor transactions being made to undergo the rigorous scrutiny of concerned government authorities to avoid any risks associated with such transactions and save the scarce foreign exchange reserves from being frittered away in some transactions considered unimportant or anti-national by the government. The Foreign Exchange Regulation Act (FERA) that was enacted in 1947 and made more stringent in 1973 was the embodiment of the prevailing sentiment of the governments of those days, which was to completely regulate and control all the foreign exchange transactions and protect the foreign currency reserves. (Mehta, 1985)

All these changed in the nineties of the last century with the opening up of Indian economy in 1991 in keeping with the recommendations of the 'High Level Committee on Balance of Payments' set up under the chairmanship of Dr C. Rangarajan by the Ministry of Finance, Government of India and subsequent entry of India into World Trade Organization (WTO) in 1994. This was preceded by the liberating of current account transactions and establishing full convertibility of current account transactions in 1993. In 1994 also the Government of India accepted Article VIII of Agreement of the International Monetary Fund that established the system of current account convertibility and the exchange value of rupee came to be determined according to the market rates with only the convertibility of capital account being under the control of the government (Krueger,2002) as the Tarapore Committee on Capital Account Convertibility of 1997 (Panagariya A., 2008) suggested the government to keep adequate safeguards before allowing the convertibility of capital account to be determined according to the market forces as there was need to consolidate the financial system and have an accepted inflation target before such a venture.

The Tarapore Committee also suggested that the legal framework governing the foreign exchange transaction system in India also needs to be modernized before going for total convertibility of the capital account due to which the Government repealed the FERA Act of 1973 and promulgated the Foreign Exchange Management Act (FEMA) in 2000.

This new act did away with the system of regulation and control and established a system of facilitation and management of foreign exchange transactions thereby promoting all the activities related to foreign exchange transactions. The most important thing that was done by FEMA was to recognize violations or mistakes in foreign exchange transactions as a civil offence instead of a criminal offence as was done by FERA. FEMA also shifted the responsibility of proving the violation or mistake in foreign exchange transaction and related rules from the prosecutor to the prosecuted. And if the prosecuted was proved guilty he or she was to pay only monetary fine or compensation instead of being jailed as was the earlier provision under FERA. FEMA also simplified many of the rules and notified specific time frames for delivering judgments related to violations of foreign exchange rules and regulations and provide rules for establishing special tribunals and forums to deal with such cases. The compounding rules were also made less stringent and all matters related to compounding rules were notified to be dealt by Reserve Bank of India (RBI) instead of the previously assigned Enforcement Directorate. RBI was made the designated 'Compounding Authority' in all related matters. Only the cases involving hawala transactions were left from its purview

As per Mecklal and Chandrasekhar, 2006, Regarding convertibility of rupee, the government of India under the FEMA guidelines, made provisions to find ways to bypass the restrictions of procedure coming in the way of free flow of foreign exchange. So many modes like External Commercial Borrowings (ECB), FDI, ADR / GDR and NRI Deposits, providing NRI Status special allowances to students studying abroad and giving special allowances to resident Indians were instituted to help overseas investments and transfer of funds beyond the national shores and give an outlet to avoid the difficulties and delays including long procedures and get instant solution to their foreign exchange requirements (www.femaonline.com).

The Committee on Procedures and Performance Audits on Public Services (CPPAPS) has initiated schemes like 'Know Your Customer (KYC)' that tries to understand customers requirements in the field of foreign exchange related services and makes the transactions quick and hassle free with lesser amount of paperwork. Apart from this the government has given authorization to many institutions to deal in foreign exchange. This caters to the foreign exchange and related needs of many customers and provides wider access of foreign exchange services to the customers (www.femaonline.com).

2.7 Features of Foreign Exchange Market in India:

The information gathered from official sources reveal that the foreign exchange market in India has become quite vibrant in recent due to the influence of globalization and widespread change in policy at the government level pertaining to the foreign exchange market and its different services though the RBI still remains the final and only interpreter of any policy and policy related issues related to foreign exchange transactions. It determines the Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) that is required for foreign exchange transactions. It was only RBI that included in its policy such measures like special deposit schemes for Non-Resident Indians (NRI), providing liberal policies to Public Sector Units (PSU) for their foreign exchange needs and lifting the restrictive clauses in the government's policies related to gold.

Today this market in India from the suppliers' side constitutes not only the government section i.e. the RBI but also includes Authorized Dealers in Foreign Exchange (AD) among whom the State Bank of India (SBI) is the largest Authorized Dealer (AD) in foreign exchange. From the operational point the foreign exchange market is divided into merchant segment that deals directly with the customers and the inter-bank segment that coordinates and facilitates the transactions in foreign exchange. From the customer side the largest seekers of foreign exchange related services can be the private and public sector business and corporate houses followed by other groups and special projects especially Foreign Institutional Investors (FII) needing foreign exchange services apart from the vast section of individual citizens and foreigners needing foreign exchange for various purposes all operating under the broad framework and policies along with the conventions provided by the RBI. Along with this the Authorized dealers (AD) have an association called the Foreign Exchange Dealers Association of India (FEDAI) that provides the guidelines for determination of commission and other related matters for around one hundred members of FEDAI who are mainly located in the major cities of India like Delhi, Mumbai, Kolkata, Chennai, Bangalore and Ahmadabad etc. (www.fedai.org.in).

2.8 Foreign Exchange Market Development:

The foreign exchange market in India has developed immensely in terms of volume and nature of business and the facilities that are being offered for it by the government. Today there is lesser amount of paperwork and procedures in accessing foreign exchange for various needs be it an individual citizen or a corporate house. Most of the developments that were made in the foreign exchange regime were initiated by the recommendations of the 'Fourteen Member Expert Group on Foreign Exchange' called 'Sodhani Committee' in 1994 (Sodhani O.P., 1995), which made 33 recommendations for the development of foreign exchange regime in India out of which around 25 recommendations were accepted by the government. These recommendations aimed at aligning the foreign exchange system of the country with that of contemporary global requirements.

Some of the prominent recommendations are mentioned below:

Freedom to fix net overnight position limit and gap limits although RBI is formally approving these limits

Replacing the system of across-the board or RBI prescribed limits

Freedom to initiate trading position in the overseas markets

Freedom to borrow or invest funds in the overseas markets (up to 15 per cent of Tier I Capital unless otherwise approved)

Freedom to determine the interest rates (subject to a ceiling) and maturity period of Foreign Currency Non-Resident (FCNR) deposits (not exceeding three years)

Exempting inter-bank borrowings from statutory pre-emptions (subject to minimum statutory requirement of 3 per cent and 25 per cent in respect of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) for the total net liabilities respectively)

Freedom to use derivative products for asset-liability management

Allowing Corporate Houses noticeable freedom to operate in the forex market

Permitting corporate houses to hedge anticipated exposures

Exchange Earners Foreign Currency (EEFC) account eligibility has been increased and the permissible end-uses widened.

Corporate Houses have been given the freedom to cancel and rebook forward contracts

Corporates can also avail of lower cost option strategies like range forwards and ratio range forwards and others as long as they do not end up as net writers of options

Corporate Houses have been given some degrees of freedom to manage exposures in External Commercial Borrowings without having to approach authorities for hedging permission

Corporate Houses can access swaps with rupee as one of the currencies to hedge longer term exposures.

Other recommendations of the Sodhani Committee implemented by the Government include:

Revamping internal control guidelines of the RBI to banks and making them available to companies.

Establishingappropriate market intervention strategies to deal with market developments

Adopting internationally accepted documentation standards

Framing comprehensive risk management guidelines for banks

Adopting Basel Committee norms for computing foreign exchange position limits and recommending capital backing for open positions

Setting up a foreign exchange market committee to discuss market issues and suggest solutions

Recommendation on publishing critical data on forex transactions has been implemented, and in fact the standards of disclosure by RBI are considered to be very high now.

In practical terms the government has been encouraging specialized international trading operations like external commercial borrowings, foreign direct investments, overseas acquisition of properties and financial papers/shares as well as overseas mergers and acquisitions in line with the new global system established by WTO.

2.9 Foreign Exchange Transaction Risk Management:

It is but natural that the risks that were being hitherto faced by countries having liberal exchange regimes have now come to affect the Indian foreign exchange system. As a result the Indian companies are now faced with similar problems in the international foreign exchange market or any venture that has connections with the global foreign exchange regime. This becomes amply clear when one scrutinizes the operations of the Indian corporate that are venturing into large scale operations in the global market. A report cited in the BIS Quarterly Survey 2005 (Table given below) clearly mentions the specific types of foreign exchange related risks and problems that the Indian companies are facing in their overseas ventures especially in different types of politico-economic set-ups.




Reliance Industries Limited

Global Financing Decisions

Complexities arising due to international financing decisions covering capital structure decisions, choice of maturity, market timing, and foreign exchange risks.

Coimbatore Yarns'

Mark Receivables

Foreign exchange risk management problems covering currency of invoicing, transaction exposure and accounting implications of forward contracts.

Essar Steel Limited

Hedging in Convertible Bonds

Difficulties arising in hedging foreign exchange risk of a foreign currency convertible bond and several issues related to financial distress.

Essar Steel Limited

Comparing Cost of Funds

True cost of borrowing in relation to a competitor who achieves an apparently cheaper financing.

Essar Steel Limited

Valuation of Euro-Convertible Bonds

Valuation of foreign currency convertible bond with embedded call and put options and other issues in option valuation. This case raises issues of exchange risk, interest rate risk and exposes the true cost of borrowing during issuance of complex financial instruments.


Rights Issue

Case involving fundamental analysis, asset allocation, market risk, hedging and short sale possibilities. Also linked with issue of multiple instruments, inter-linkages between operations in primary and secondary markets. This is one of the first in the series of cases revolving around a public issue by one of India's largest private sector companies.


Rights Issue

Problems arising due to complexities of adjustment for bonus and rights issues in applying the Gordon dividend growth model.


Rights Issue

Exchange valuation problems in the mechanics and subtleties of beta computation, it being a measurement of risk in modern portfolio theory.



A case on the stability of betas over time particularly changes in betas induced by environmental changes like deregulation of foreign exchange regime.

(BIS Quarterly Survey, 2005)

The table shows that the companies mentioned are facing problems while performing basic works needed for any international project like issuing of global issues rights and bonds, global marketing programs, asset allocation, financial arrangements etc. And most of these companies are the forbearers of emerging Indian multinationals having considerable financial and market power. It only proves that the foreign exchange regime is a mechanism that has the inherent quality to increase the percentage of risk that is directly proportional to the increase in activity or intermingling of a specific financial regime with the global financial system that gives rise to different types of issues connected with the risk factor of international foreign exchange system form which even established companies cannot escape.

In specific terms the companies that are venturing into the global market or initiating some ventures in a different country and under a different financial regime are facing the problems related to computation and tallying of value of currency of both the countries and of the whole project or contract and working under different financial systems having different conventions and procedures and international transfer of currency value of individual countries (Shamah and Shamah, 2003). In fact it can be said that the risks associated with the foreign exchange systems of countries and of the whole world have come to stay. This had to happen because as of now even though the individual countries have increased their association with the global foreign exchange system they have still retained their financial policies and systems that are unique to their domestic and national requirements (Steiner, 2002) and is not in consonance with the system of other countries. In fact the genesis of foreign exchange emanates from this fundamental difference only. In fact so long as this difference remains there is bound to be increased risk in foreign exchange mechanism with increase in intermingling between the financial systems of different countries through the foreign exchange system.

2.9.1 Risks Reducing Strategies:

Hedging of foreign exchange transactions and dealing in foreign exchange in the derivatives market are the most common strategies that are followed by Indian corporate groups and other entities to minimize the risks associated with transaction in foreign exchange in the international market. Regarding providing all the facilities and support to face and tackle the risks associated with foreign exchange regime the FEDAI provides the needful support and guidance (www.fedai.org.in). A major chunk of the risks associated with foreign exchange transactions are avoided because the RBI only allows full convertibility in the current account and not in the capital account. In the same way the RBI gives blanket cover to the Indian corporate groups and other entities dealing in foreign exchange and tackles most of the risks associated with fluctuations in the value of Indian currency that has a direct influence of the exchange rate and foreign exchange regime of India. This gives the Indian corporate groups the protecting umbrella to freely chart their international business strategies (Damodaran, 2007). This leaves the inevitable risks of smaller nature like the daily fluctuations in the valuation of currencies and the procedural bottlenecks that is associated with foreign exchange system of the world Ziemba and Ziemba, 2008, has a opinion that these will remain so long as there are different financial systems existing in all the countries and there is no common system to coordinate the procedures and paraphernalia associated with foreign exchange system. Besides, the fluctuations in valuation are direct fallout of the increase in volume and traffic of international foreign exchange system and these risks are an effect of the phenomenon only.

2.10 Conclusion:

The foreign exchange system in India was almost wholly protected from the influence of the international foreign exchange system till the nineties when it was liberalized due to some inherent causes as well as some extraneous developments. Till that period the Indian financial system was totally regulated by the government with the Indian currency maintaining its exchange value with the total backing of the government. But he global developments and inherent causes made India adopt certain far reaching procedures and policies alike opening up of the economy to the global market, adopting total convertibility of the Indian currency in the current account, establishing laws and procedures for the facilitation of overseas investments as well as foreign direct investments and external commercial borrowings. The government also repealed all the restrictive laws that gave a very restrictive system to the foreign exchange mechanism like the FERA. All these processes opened the Indian foreign exchange to the different possibilities of the global system and both individual and corporate groups of India along with other players greatly benefitted from it.

But this new development also lifted the protective veil of the Indian government system that was previously being bestowed to the foreign exchange mechanism of India and the Indian currency system. The Indian currency and the foreign exchange system therefore faced risks associated with the functioning of the global foreign exchange system like fluctuations in rate, plethora of laws rules and regulations and mismatch of procedures of different countries notwithstanding the difference in time and place of transaction and closing of deals that was greatly affecting the value of foreign exchange transactions in the international market. All these developments are a consequence of greater intermingling of the Indian currency with the international monetary system. Nevertheless the Indian system in spite of the many facilities that it has provided for growth of business and economy of the country has still retained the some of the fundamental principles and policies that are giving protection and also remedies to avoid and mitigate risks associated with the international foreign exchange transaction environment. These including excluding the capital account from being fully convertible, intervening in the case of excess devaluation of the Indian currency in the market to restore its value, providing the environment to establish support groups and associations to deal with issues and problems related with foreign exchange transactions etc. The Indian corporate groups and other players dealing in foreign exchange are also trying in their own way to tackle the risks associated with foreign exchange transactions by hedging their deals and dealing in foreign exchange in the derivatives market.

All the same the risks related to transactions in foreign exchange will remain. This is because they are an inherent part of the dynamics of the foreign exchange system operating in the globe. But the better thing is that the Indian government and its system still have the basic system to protect the Indian currency from the risks associated with operating in the global foreign exchange system.

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