Trade and Exchange are probably older than the invention of money, but in the absence of this wonderful contrivance the volume of trade and gains from specialization would have been rather miniscule.
Exchange rate is a key determinant in international finance and turning of world into a global village has just made this variable all the more important..
A foreign exchange rate is the relative value between two currencies. In particular, the is exchange rate the quantity of one currency required to buy or sell one unit of the other currency.
In finance, an exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country's currency in terms of another currency.
Exchange Rate
Is the price of foreign currency.
INR/USD is usually stated as Indian rupees per dollar.
An increase in exchange rate implies depreciation in currency and vice versa.
Rate at which one currency may be converted into another. The exchange rate is used when simply converting one currency to another (such as for the purposes of travel to another country), or for engaging in speculation or trading in the foreign exchange market. There are a wide variety of factors which influence the exchange rate, such as interest rates, inflation, and the state of politics and the economy in each country, also called rate of exchange or foreign exchange rate or currency exchange rate.
The price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. For example, the higher the exchange rate for one euro in terms of one yen, the lower the relative value of the yen.
Are terms like managed float, dirty float, fixed exchange rates, floating exchange rate, pegged exchange rate, crawling peg the same?
Exchange rates are determined by demand and supply. But governments can influence those exchange rates in various ways. The extent and nature of government involvement in currency markets define alternative systems of exchange rates.
There are three broad categories of exchange rate systems.
In one system, exchange rates are set purely by private market forces with no government involvement. Values change constantly as the demand for and supply of currencies fluctuate.
In another system, currency values are allowed to change, but governments participate in currency markets in an effort to influence those values.
Finally, governments may seek to fix the values of their currencies, either through participation in the market or through regulatory policy.
From the above points it's clear that some of the terms like managed float, dirty float, fixed exchange rates, floating exchange rate, pegged exchange rate, crawling peg are the same but not all i.e managed float is also termed as dirty float , fixed exchange rate is same as pegged exchange rate.
Free-Floating Systems
In a free-floating exchange rate system, governments and central banks do not participate in the market for foreign exchange. The relationship between governments and central banks on the one hand and currency markets on the other is much the same as the typical relationship between these institutions and stock markets. Governments may regulate stock markets to prevent fraud, but stock values themselves are left to float in the market. The U.S. government, for example, does not intervene in the stock market to influence stock prices.
The concept of a completely free-floating exchange rate system is a theoretical one. In practice, all governments or central banks intervene in currency markets in an effort to influence exchange rates. Some countries, such as the United States, intervene to only a small degree, so that the notion of a free-floating exchange rate system comes close to what actually exists in the United States.
A free-floating system has the advantage of being self-regulating. There is no need for government intervention if the exchange rate is left to the market. Market forces also restrain large swings in demand or supply. Suppose, for example, that a dramatic shift in world preferences led to a sharply increased demand for goods and services produced in Canada. This would increase the demand for Canadian dollars, raise Canada's exchange rate, and make Canadian goods and services more expensive for foreigners to buy. Some of the impact of the swing in foreign demand would thus be absorbed in a rising exchange rate. In effect, a free-floating exchange rate acts as a buffer to insulate an economy from the impact of international events.
The primary difficulty with free-floating exchange rates lies in their unpredictability. Contracts between buyers and sellers in different countries must not only reckon with possible changes in prices and other factors during the lives of those contracts, they must also consider the possibility of exchange rate changes. An agreement by a U.S. distributor to purchase a certain quantity of Canadian lumber each year, for example, will be affected by the possibility that the exchange rate between the Canadian dollar and the U.S. dollar will change while the contract is in effect. Fluctuating exchange rates make international transactions riskier and thus increase the cost of doing business with other countries.
Managed Float Systems
Governments and central banks often seek to increase or decrease their exchange rates by buying or selling their own currencies. Exchange rates are still free to float, but governments try to influence their values. Government or central bank participation in a floating exchange rate system is called a managed float.
Countries that have a floating exchange rate system intervene from time to time in the currency market in an effort to raise or lower the price of their own currency. Typically, the purpose of such intervention is to prevent sudden large swings in the value of a nation's currency. Such intervention is likely to have only a small impact, if any, on exchange rates. Roughly $1.5 trillion worth of currencies changes hands every day in the world market; it is difficult for any one agency-even an agency the size of the U.S. government or the Fed-to force significant changes in exchange rates.
Still, governments or central banks can sometimes influence their exchange rates. Suppose the price of a country's currency is rising very rapidly. The country's government or central bank might seek to hold off further increases in order to prevent a major reduction in net exports. An announcement that a further increase in its exchange rate is unacceptable, followed by sales of that country's currency by the central bank in order to bring its exchange rate down, can sometimes convince other participants in the currency market that the exchange rate will not rise further. That change in expectations could reduce demand for and increase supply of the currency, thus achieving the goal of holding the exchange rate down.
This system is also known as Dirty Float
Fixed Exchange Rates
In a fixed exchange rate system, the exchange rate between two currencies is set by government policy. There are several mechanisms through which fixed exchange rates may be maintained. Whatever the system for maintaining these rates, however, all fixed exchange rate systems share some important features.
A fixed exchange rate, sometimes called a pegged exchange rate, is also referred to as the Tag of particular Rate, which is a type of exchange rate regime where a currency's value is fixed against the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.
The crawling peg
Is a semi-finished system, adjusts the exchange rate slowly by small amounts at any point in time on a continuous basis to correct for any overvaluation and under-devaluation. The continuous but small adjustments mechanism was designed to discourage speculation by setting an upper limit that speculators could gain from devaluation in one year.
Main points of difference,
In the case of floating , a currency is allowed to seek it's own value based on the demand, supply and market conditions. Unlike Crawling peg there is no movement limit.
Under fixed exchange rate system the exchange rate between two currencies is set by government policy not by the forces of demand and supply and market conditions.
And last but not the least manged or dirty float differs from the floating and fixed system as under it Governments and central banks often seek to increase or decrease their exchange rates by buying or selling their own currencies. Exchange rates are still free to float, but governments try to influence their values.
Which type of exchange rate regime does India follow?
Now most of the countries follow a free floating exchange rate system. India's approach can be characterized as intermediate since it follows a system between a freely floating and fully managed system. This type of system is known as managed float system. Exchange rates are allowed to float freely, but RBI intervenes when it feels necessary in the way it considers suitable. For e.g. in order to curb appreciation of INR it may buy USD from the market or it may increase the interest rates.
What is a currency crisis?
A situation in which the value of a currency becomes unstable, making it difficult for the currency to be used as a reliable medium of exchange. The effect of a currency crisis can be mitigated by sufficient foreign reserves. A currency crisis is a type of financial crisis.
In recent times the rupee is becoming weaker against the dollar every day.
Indian rupee is at a historic low. Every day the downslide of the rupee makes for headline news.
The rupee sliding with every passing day the reasons for the same are:-
Reasons
The principle reason why the value of the Indian currency has come down sharply in relation to the US dollar is the huge 56 per cent hike in the country's trade deficit (the difference between the value of imports and exports) in 2011-12 over the previous year.
This is because of the fact that while imports have risen by nearly a third , the rate of growth of exports in 2011-12 has halved from the 41 per cent growth achieved in previous fiscal year (2010-11)
In the past 5 years, edible oil imports have almost doubled.
Another reason is, the high rate of inflation, in our economy, which is now around 9%, one of the highest rates in the world. It erodes the value of rupee and thus calls for continuous downward adjustment against the dollar for maintaining the proper parity value.
the high rate of fiscal interest is also responsible, as it increases the cost of doing business and makes products and services costly, reducing their competivity in the global markets
The recent downgrading of India by Standard & Poor international rating agency has resulted in flight of dollars by FII's who quit from the share markets thus leading to a further shortage of dollars. One has also to factor that some Indians may be stashing dollars illegally abroad.
The foreign currency inflow of funds has gone down in recent times because of which there is a pressure on value of rupee. In fact there has been a net outflow of funds outside India
The global crisis has resulted into investors putting their money into $. This has resulted in investments being withdrawn from rupee.
The current political scenario and policy paralysis have erased foreign investors faith in Indian economy, which has resulted into the fall of value of currency.
Measures
The following are the moves made by RBI in order to stop the rupee from further depreciation:
To allow Indian companies in manufacturing and infrastructure sector and having foreign exchange earnings to avail of ECB for repayment of outstanding rupee loans towards capital expenditure and/or fresh rupee capital expenditure under the approval route. The overall ceiling for such ECBs would be USD 10 billion.
Increased the limit of overseas investment in government bonds by USD 5 billion to USD 20 billion.
The terms and conditions for the scheme for FII investment in infrastructure debt and the scheme for non-resident investment in Infrastructure Development Funds (IDFs) have been further rationalized in terms of lock-in period and residual maturity.
Further, Qualified Foreign Investors (QFIs) can now invest in those mutual funds (MF) schemes that hold at least 25 per cent of their assets (either in debt or in equity or both) in infrastructure sector under the current USD 3 billion sub-limit for investment in mutual funds related to infrastructure.
RBI is expected to hike the interest rate for deposits of non-resident Indians (NRIs) in banks and unveil a special bond issue for overseas investors offering higher rates of interest to attract foreign currency into the system, which will result in strengthening the rupee.
RBI said EEFC account holders will be permitted to access the market for purchasing foreign exchange only after using up all the money in their accounts. That means they wouldn't be able to hold their foreign exchange earnings and wait for a favourable exchange rate at which to sell the money.
RBI's message is plain and simple - don't indulge in speculation. Use the currency market for genuine purposes, not for profit making.
Indian Rupee is certainly depreciating against US dollar.
The Rupee Depreciating So Badly :-
Because of many factors that are occurring in a simultaneous fashion. The crucial ones are:
1. Due to Risk Aversion on the part of Currency Investors, the Demand for the US Dollar
has gone up world over
2. Uncertain Economic Situation around the globe
3. FII's turning Net-Sellers and withdrawing funds from the Indian Market
Conclusion
Accounting for the Rupee
The rupee has depreciated steeply against the dollar. Newspapers often show a picture of the INR/USD exchange rate from August 2011 (45.3) to Aug 2012 (around 53-54) to highlight the 18% decline in that period. That is depressing enough. But if the exchange rate is viewed from the beginning of its managed float era, say, from March 1992, it becomes obvious what all the media fuss is about. The exchange rate is majorly a function of Demand & Supply. The govt. policies lack of initiative on the reforms front, subsidies etc are some of the reasons that is influencing the exodus of the $. Hope RBI take some corrective steps early and hope that Rs 56 to a $ looks attractive to FIIs to start investing into the stock market
Chart A: INR/USD exchange rate based on RBI reference rate
Chart B: (INR per 1 USD)rate from June 1, 2012 to Sept 9, 2012 Chart C (USD per 1 INR)rate from June 1, 2012 to Sept 9, 2012
