India: India’s Foreign Exchange Market

Last Updated: 9 April 2001

Introduction

India began its integration with the world economy with the beginning of the 1990s. Since then, the foreign trade has grown at an average rate of 8.1% every year. During this period, capital inflows grew even faster. And increasingly, Indian businesses have found greater foreign exchange in their cash flows.

History

Until 1993, India maintained an administrative exchange rate. From its independence from the British to 1971, India had a fixed exchange rate against the currency of its former rulers. This was however done in consultation with the International Monetary Fund. After the collapse of the fixed exchange rate system in 1971, the currency was linked to the British pound, but not for long. As other economies gained prominence in India’s economic relations, there was a need to maintain stability vis-à-vis with other currencies too. 1975 onwards, the Indian rupee was linked to a basket of currencies and was devalued from time to time in order to maintain stability. Following India’s economic liberalisation in 1991, the currency was devalued by 18% and administered exchange rate lived side by side the market too. Also, the Indian currency began being quoted against the U.S. dollar – a change from its pound based quote. It was only in 1993, that the rupee was made to float. The Indian currency was now tradable in the market.

The Foreign Exchange Market

India's forex market is a multi-tiered market where the commercial banks that quote the domestic unit against the US dollar, are at the centre of activity. The rupee is not quoted against any other currency in this rate discovering market. Businesses that need to transact in foreign currency, do so with an authorised dealer (generally a commercial bank) as they are not permitted to deal directly with each other.

In general, the rupee's exchange rate is characterised by stability against the dollar followed by a sharp depreciation ranging from 2% to 7%. However, if one takes into account inflation and the movement of other major currencies like the yen, mark and the pound, the domestic currency has been nearly stable in the past seven years. The central bank comes in from time to time in the market to buy or to sell dollars in order to stabilise the market, which it does successfully. The central bank is also sometimes nearly absent from the market, even during a movement.

Recent Developments:

Last year, the Indian rupee slid 7% against the dollar to INR 46.90 per USD. The high international prices of oil were chiefly blamed for the rupee's decline. India's oil imports had soared by over 60% during the April -December period of 2000. Also, portfolio investments did not seem to grow in a stagnant stock market that had already lost a third of value from its peak during the year. Only after the largest commercial bank, the State Bank of India (SBI) borrowed over five billion dollars from overseas Indians, did the confidence in the domestic currency crawl back. From another point of view, even after the 7% fall of the domestic currency, it stood at the same level as it was at the time it was made to float in early nineties. Central bank's own published data on the inflation adjusted & trade weighted rate for the rupee with respect to 93-94, stood neutral/unchanged after the fall. In other words, the rupee was overvalued before the fall began in May 2000. A third of India's exports go to Europe. This makes it difficult to ignore the movements in the euro's exchange rate. By April 2000, the rupee had appreciated by 19% against the euro since August 1999. And at that point of time the inflation rate stood at 6½%. For the purpose of analysing the rupee, the focus has traditionally been on the current account. The capital account flows and its impact on the exchange rate started gaining significance only in the 1990s. The size of capital account transactions is smaller at $ 70 billion and is half the size of current account transactions. Nevertheless, portfolio investment is a volatile figure that can affect the exchange rate in the short run. During June & July in 2000, foreign portfolio investors sold $ 526 million worth of assets in the Indian market. And in the first three months of 2001, they bought assets worth $ 1.7 billion. However, in the financial year 1999 - 2000 (April 1999 to march 2000), portfolio flows were only an eighth of the current account flows. Moreover, with the rupee being fully convertible only on the current account, the focus tends to be more on the trade. On one hand, a strong rupee hurts the exports, on the other a significantly weak rupee can fuel inflation.

Risk & Derivatives:

On the derivatives side, there is a forward market for rupee: dollar. Interestingly, this market is not based on the interest parity principle as in other markets. If more dollars are sold forward, the premium on the dollar tends to be lower, and vice-versa. The local forward market is greatly influenced by the current account transactions, with the exception of forward dollars bought for debt servicing. The importers and exporters are chief participants in the forward market. This market is liquid upto a maturity of one-year. Beyond that, the transactions are more on individual basis between the banks and their clients. Because the market is quoted only in dollars, other currencies are quoted on the basis of prevailing international rates. For example, the spot rupees per euro exchange rate is derived by multiplying the international $ per euro rate by the domestic rupee per dollar rate. The same mechanism also extends for the forward rates, where demand supply generated rate in one market is crossed with the interest rate differential generated rate in the other. Futures and options are absent from India's foreign exchange market, due to regulatory restrictions. However, commercial banks can sell options to Indian businesses in cross currencies by buying the same from international markets. Indian businesses are not allowed to write options under any circumstances. The central bank has adopted a very cautious approach to opening up of the derivatives market and does not wish to expose the banks and businesses to risks that they may not yet be ready to deal with. The same philosophy is also adopted in the spot market (the underlying market) where the volatility is curtailed.  But, businesses with payables in foreign currency might find themselves on the receiving end when the currency begins to slide by a sizeable magnitude after months-long stability. On the other hand, businesses with foreign currency receivables face risk in terms of the rupee's appreciation (like last year’s rise over euro). Many businesses are beginning to manage these risks. However, the currency risk is better-understood vis-à-vis the USD than other currencies, primarily on account of the market being a rupee: dollar one. INR: USD swaps are also a part of the market. Swaps can be undertaken between a bank & its client, though regulation forces banks to keep their positions arising out of such deals, square.

From Here

In the last decade, the size of India's foreign exchange markets has not kept pace with the growth in foreign exchange flows. This has not helped liquidity and aggravates risks by way of volatility.  India has moved slowly but steadily towards its goal of a more open economy. This trend is likely to continue in the foreseeable future. India’s experiment with capital account convertibility would be a case study of huge significance to most emerging economies who would like to benefit from its positive aspects, considering that after the Asian crisis in 1997-98 the reversal of international capital flows has become a scary word for many developing economies. Now, Indian companies can also invest abroad (though not without some restrictions). As India integrates with and develops markets overseas, risks vis-à-vis many other currencies becomes apparent. That leaves a lot of scope for development in derivatives market – in rupee: dollar and also dollar: international currencies in India.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions