MVOC
SEM-2
UNIT-3
FOREIGN EXCHANGE MARKETS AND INDIA
It seems like you're asking about "Financial and Economic Regulations and Management."
Financial and economic regulations refer to the rules and guidelines set by governments or
regulatory bodies to oversee and control various aspects of the financial and economic
systems within a country or region. Financial management, on the other hand, involves the
efficient and effective management of financial resources within an organization to achieve
its objectives.
FE Regulations and Managements:
Let's break down each aspect and provide an example:
Financial Regulations:
Financial regulations encompass a wide range of rules and laws aimed at maintaining
stability, protecting investors, and preventing fraud within financial markets. These
regulations often cover areas such as banking, securities trading, insurance, and accounting
standards.
Example: The Dodd-Frank Wall Street Reform and Consumer Protection Act in the United
States is a comprehensive set of financial regulations enacted in response to the 2008
financial crisis. One of its provisions is the Volcker Rule, which prohibits banks from certain
speculative investments that do not benefit their customers. This regulation aims to prevent
banks from taking excessive risks that could lead to financial instability.
Economic Regulations:
Economic regulations focus on controlling various aspects of the economy to promote fair
competition, consumer protection, and overall economic stability. These regulations can
include price controls, antitrust laws, environmental regulations, and labor laws.
Example: Antitrust laws are a type of economic regulation designed to prevent monopolies
and promote competition. For instance, the European Union's competition regulator, the
European Commission, fined Google for violating antitrust laws by favoring its own
shopping comparison service over those of its competitors in search results. This regulation
aims to ensure fair competition and prevent one company from dominating the market to the
detriment of consumers.
Financial Management:
Financial management involves the planning, organizing, directing, and controlling of an
organization's financial resources to achieve its goals and objectives. It includes activities
such as budgeting, financial reporting, investment management, and risk management.
Example: A company's financial management practices can be illustrated by its budgeting
process. For instance, a manufacturing company may create an annual budget that outlines
expected revenues and expenses for the upcoming year. The budget may allocate funds for
various departments, such as production, marketing, and research and development, based on
projected needs and priorities. Throughout the year, financial managers monitor actual
financial performance against the budget and make adjustments as needed to ensure the
company remains on track to meet its financial goals.
In summary, financial and economic regulations are rules and laws aimed at overseeing and
controlling various aspects of financial and economic systems, while financial management
involves the efficient and effective management of financial resources within an organization.
These concepts are essential for maintaining stability, promoting fair competition, and
achieving organizational objectives.
ROLE OF ECGC:
The Export Credit Guarantee Corporation of India (ECGC) and the Export-Import Bank of
India (EXIM Bank) play crucial roles in facilitating international trade and mitigating risks
associated with exports and imports. Let's delve into the roles of each with examples:
Export Credit Guarantee Corporation of India (ECGC):
ECGC provides export credit insurance to exporters and banks to protect them against losses
due to non-payment by buyers, political risks, or other trade-related risks. Its main role is to
promote and support Indian exports by providing a range of credit risk mitigation tools.
Role:
Offering export credit insurance: ECGC offers various types of export credit insurance
policies that protect exporters against commercial and political risks. These policies provide
coverage against non-payment by overseas buyers due to insolvency, protracted default, or
political events like war or currency inconvertibility.
Facilitating trade finance: By providing export credit insurance, ECGC enhances exporters'
access to trade finance from banks and financial institutions. Banks are more willing to
finance export transactions when they are covered by ECGC's insurance policies, reducing
the exporters' financial risk.
Promoting exports to risky markets: ECGC encourages Indian exporters to explore new and
challenging markets by providing insurance coverage for exports to countries with higher
perceived risks.
Example:
Suppose an Indian textile manufacturer wants to export a shipment of fabrics to a buyer in a
foreign country with a history of political instability. The manufacturer can obtain export
credit insurance from ECGC to protect against the risk of non-payment if the buyer defaults
due to political unrest in their country. With ECGC's insurance coverage, the manufacturer
can proceed with the export transaction with confidence, knowing that they are protected
against potential losses.
ROLE OF EXIM BANK:
EXIM Bank is the premier export finance institution in India, tasked with financing,
facilitating, and promoting India's international trade. It provides a range of financial services
and assistance to Indian exporters and importers to boost foreign trade and investment.
Role:
Providing export finance: EXIM Bank offers various financing facilities, including pre-
shipment and post-shipment credit, to exporters to support their working capital needs and
enable them to fulfill export orders.
Facilitating export promotion: EXIM Bank assists Indian exporters in identifying export
opportunities, accessing new markets, and participating in international trade fairs and
exhibitions to promote their products and services globally.
Promoting project exports: EXIM Bank supports Indian companies involved in project
exports by providing financing, advisory services, and guarantees to facilitate their
participation in overseas infrastructure projects and construction contracts.
Example:
Suppose an Indian engineering firm secures a contract to build a highway in a foreign
country. To finance the project, the firm seeks assistance from EXIM Bank, which provides
project finance and guarantees to support the export of goods and services required for the
project. With EXIM Bank's financing and support, the Indian firm can execute the project
successfully, contributing to India's exports and economic growth.
In summary, ECGC and EXIM Bank play complementary roles in supporting Indian
exporters and mitigating risks associated with international trade. ECGC provides export
credit insurance to protect against commercial and political risks, while EXIM Bank offers
export finance and assistance to facilitate trade and promote India's exports and investments
globally.
RBI MECHANISM FOR REGULATING FOREIGN EXCHANGE MARKETS:
The Reserve Bank of India (RBI) plays a pivotal role in regulating the foreign exchange
markets in India. It does so through various mechanisms aimed at maintaining stability,
promoting orderly conduct, and ensuring the efficient functioning of the foreign exchange
market. Let's explore the mechanisms employed by RBI, along with an example:
Foreign Exchange Management Act (FEMA):
FEMA is the primary legislation governing foreign exchange transactions in India. It
provides the legal framework for regulating foreign exchange transactions, dealings in
foreign currency, and the acquisition and transfer of immovable property outside India.
Role: RBI administers FEMA and formulates regulations under its provisions to regulate
foreign exchange transactions and monitor cross-border capital flows.
Example:
Suppose an Indian company wants to invest in a foreign subsidiary or acquire a company
abroad. Before proceeding with the transaction, the company must comply with FEMA
regulations, including obtaining approval from RBI or authorized dealers for remitting funds
overseas and adhering to prescribed limits on outward investments.
Foreign Exchange Reserves Management:
RBI maintains foreign exchange reserves to intervene in the foreign exchange market and
stabilize the rupee's exchange rate against major currencies. These reserves consist of foreign
currencies, gold, Special Drawing Rights (SDRs), and reserve position in the International
Monetary Fund (IMF).
Role: RBI uses its foreign exchange reserves to manage exchange rate volatility, provide
liquidity support to the market, and maintain external stability.
Example:
In times of excessive volatility or speculative attacks on the rupee, RBI may intervene in the
foreign exchange market by buying or selling foreign currencies to stabilize the exchange
rate. For instance, if the rupee depreciates sharply against the US dollar due to speculative
trading, RBI may sell US dollars from its reserves to counter the depreciation and restore
stability to the currency market.
Foreign Exchange Market Operations:
RBI conducts various foreign exchange market operations, such as open market operations
(OMOs), foreign exchange swaps, and forward contracts, to manage liquidity conditions and
influence exchange rates.
Role: Through market operations, RBI aims to regulate liquidity in the foreign exchange
market, align exchange rates with underlying economic fundamentals, and ensure the orderly
functioning of the market.
Example:
During periods of tight liquidity in the foreign exchange market, RBI may conduct forex
swaps by simultaneously buying and selling foreign currencies with authorized dealers to
inject liquidity into the market. By providing rupee liquidity against foreign currency assets,
RBI ensures that market participants have access to adequate funds for their foreign exchange
transactions, thereby maintaining market stability.
In summary, RBI regulates the foreign exchange markets in India through mechanisms such
as FEMA compliance, foreign exchange reserves management, and market operations. These
mechanisms help RBI maintain stability, manage exchange rate volatility, and promote
orderly conduct in the foreign exchange market, thereby supporting India's external sector
and overall economic stability.
FE Markets Recommendations of expert committees on FE markets (Sodhani
Committee):
The Sodhani Committee, officially known as the "Committee on Fuller Capital Account
Convertibility," was formed by the Reserve Bank of India (RBI) in 2006. The committee was
chaired by S.S. Tarapore, a former deputy governor of the RBI. Its primary objective was to
examine the issues related to fuller capital account convertibility (FCAC) in India and
provide recommendations for the orderly liberalization of the country's foreign exchange
markets. The concept of FCAC refers to the freedom to convert local financial assets into
foreign financial assets and vice versa without significant restrictions.
Here are some key recommendations of the Sodhani Committee along with examples:
Phased Approach to Capital Account Liberalization:
The committee recommended adopting a phased approach to liberalizing India's capital
account. It suggested gradual relaxation of controls on capital flows while simultaneously
strengthening macroeconomic fundamentals and regulatory frameworks.
Example:
Suppose India decides to liberalize its capital account to allow foreign investors to invest
freely in Indian financial markets. Instead of opening up all sectors at once, the government
could initially permit foreign direct investment (FDI) in select sectors, such as
telecommunications or infrastructure, while maintaining restrictions on other sectors. Over
time, as the economy becomes more resilient and regulatory frameworks are strengthened,
further sectors could be opened up to foreign investment.
Strengthening Regulatory and Supervisory Frameworks:
The committee emphasized the importance of strengthening regulatory and supervisory
frameworks to manage risks associated with capital account liberalization effectively. This
included enhancing the capacity of regulatory authorities, improving risk management
practices, and enhancing transparency and disclosure standards.
Example:
To ensure the stability of India's financial system amid increased capital flows, regulatory
authorities such as the RBI and the Securities and Exchange Board of India (SEBI) may
introduce stricter prudential norms for banks and financial institutions. They may also
enhance surveillance mechanisms to monitor cross-border transactions and mitigate the risks
of financial contagion.
Deepening Financial Markets:
The committee highlighted the need to deepen India's financial markets to accommodate
increased capital flows and enhance liquidity. This involved developing robust infrastructure
for trading, settlement, and clearing of financial instruments, as well as promoting the
development of derivative markets.
Example:
To attract foreign portfolio investors (FPIs) and promote liquidity in the Indian equity market,
regulatory authorities may introduce measures to simplify the registration process for FPIs
and enhance market infrastructure, such as introducing electronic trading platforms and
improving settlement mechanisms. These initiatives would make it easier for foreign
investors to access Indian capital markets and contribute to market deepening.
Gradual Relaxation of Controls on Outward Investments:
The committee recommended gradually relaxing controls on outward investments by Indian
residents to promote diversification of investment portfolios and encourage outbound capital
flows.
Example:
Indian residents may be allowed to invest in a broader range of foreign assets, including
equities, bonds, and real estate, subject to certain limits and conditions. This would enable
investors to diversify their portfolios, hedge against domestic risks, and access investment
opportunities in global markets.
In summary, the recommendations of the Sodhani Committee on fuller capital account
convertibility aimed to provide a roadmap for the gradual liberalization of India's foreign
exchange markets while ensuring macroeconomic stability, strengthening regulatory
frameworks, deepening financial markets, and promoting outbound investments.
LERMS, Convertibility: Capital and Current Accounts (Tarapore Committee
Report):
The Tarapore Committee Report, officially known as the "Report of the Committee on Fuller
Capital Account Convertibility," was commissioned by the Reserve Bank of India (RBI) in
1997. The committee, chaired by former RBI deputy governor S.S. Tarapore, aimed to
provide recommendations on achieving fuller capital account convertibility (FCAC) while
maintaining macroeconomic stability. The report addressed various aspects of convertibility,
including the Liberalized Exchange Rate Management System (LERMS) and the distinction
between capital and current accounts convertibility. Let's explore these concepts with
examples:
Liberalized Exchange Rate Management System (LERMS):
LERMS was introduced in India in 1992 as a transitional mechanism to move towards a
market-determined exchange rate regime. Under LERMS, India had two exchange rates: an
official exchange rate determined by the RBI for essential imports and a market-determined
exchange rate for non-essential imports and exports.
Example:
Suppose India imports crude oil, which is crucial for its energy needs and economic stability.
Under LERMS, the RBI may fix an official exchange rate for purchasing crude oil to ensure
its affordability and availability in the domestic market. However, for non-essential imports
like luxury goods, the exchange rate would be determined by market forces, allowing for
greater flexibility and reflecting supply and demand dynamics.
Convertibility: Capital and Current Accounts:
The Tarapore Committee distinguished between capital and current account convertibility.
Current account convertibility refers to the freedom to convert local currency for trade in
goods and services, while capital account convertibility allows for the free flow of capital in
and out of the country for investment purposes.
Example:
Current Account Convertibility: Suppose an Indian company exports software services to a
foreign client and receives payment in US dollars. With current account convertibility, the
company can freely convert the received dollars into Indian rupees to pay for its operational
expenses or repatriate profits without any significant restrictions.
Capital Account Convertibility: Now, consider a scenario where a foreign investor wants to
invest in an Indian company by purchasing shares on the Indian stock exchange. With capital
account convertibility, the investor can freely convert their foreign currency into Indian
rupees, invest in the shares, and repatriate capital gains or dividends back to their home
country without encountering significant regulatory barriers.
The Tarapore Committee Report provided a roadmap for the gradual liberalization of India's
foreign exchange regime, emphasizing the importance of maintaining macroeconomic
stability and strengthening regulatory frameworks to manage risks associated with capital
account convertibility. By implementing the recommendations of the committee, India aimed
to enhance its integration into the global economy, attract foreign investment, and promote
sustainable economic growth.
Balance of Trade & Payment - Financing of imports & exports by banks - Facilities to
exporters.
Balance of Trade and Balance of Payments:
Balance of Trade: This refers to the difference between the value of a country's exports and
imports of goods. If the value of exports exceeds imports, the country has a trade surplus; if
imports exceed exports, the country has a trade deficit.
Balance of Payments: This is a broader measure that includes not only the balance of trade
in goods but also the balance of trade in services, income flows (such as interest and
dividends), and unilateral transfers (such as remittances). It provides a comprehensive view
of a country's economic transactions with the rest of the world.
Example:
Suppose Country A exports automobiles and electronics worth $100 billion but imports oil
and machinery worth $120 billion in a given year. In this case, Country A has a trade deficit
of $20 billion. However, if Country A earns $30 billion from foreign investments and
receives $10 billion in remittances, its balance of payments may still be positive, even though
it has a trade deficit.
Financing of Imports and Exports by Banks:
Import Financing: Banks provide various financing options to importers to facilitate their
purchases of goods and services from foreign countries. These options may include letters of
credit, bank guarantees, import loans, and trade finance facilities. Import financing helps
importers manage cash flow and mitigate the risks associated with international trade.
Export Financing: Similarly, banks offer financing solutions to exporters to support their
sales of goods and services in international markets. Export financing options may include
pre-shipment finance, post-shipment finance, export factoring, export credits, and export
credit insurance. Export financing enables exporters to fulfill orders, expand their business,
and manage risks associated with foreign trade.
Example:
Import Financing: Suppose an importer in Country B wants to purchase machinery from a
manufacturer in Country C. To finance the purchase, the importer approaches a bank in
Country B and applies for an import loan. The bank evaluates the importer's creditworthiness
and the terms of the transaction before providing financing. Once approved, the bank
disburses the loan amount to the exporter's bank in Country C, allowing the importer to
receive the machinery.
Export Financing: Consider a scenario where a manufacturer in Country D wants to export
textiles to a buyer in Country E. To fulfill the export order, the manufacturer obtains pre-
shipment finance from a bank in Country D. With this financing, the manufacturer procures
raw materials, produces the textiles, and ships them to the buyer. After the goods are
dispatched, the exporter presents shipping documents to the bank to receive post-shipment
finance, allowing them to bridge the gap between shipment and payment receipt.
Facilities to Exporters:
Export Credit Guarantee: Banks may offer export credit guarantees to exporters to protect
them against non-payment risks arising from commercial or political factors. These
guarantees provide exporters with assurance that they will receive payment for their exports
even if the buyer defaults.
Export Promotion Schemes: Governments often implement export promotion schemes to
incentivize and support exporters. These schemes may include subsidies, tax incentives, duty
drawback schemes, and export finance facilities to reduce the cost of exports and enhance
competitiveness in international markets.
Example:
Export Credit Guarantee: An exporter in Country F enters into a contract to supply
agricultural products to a buyer in Country G. To mitigate the risk of non-payment, the
exporter obtains export credit insurance from a bank or an export credit agency. In case the
buyer fails to pay due to insolvency or political events, the insurance policy compensates the
exporter for the loss incurred.
Export Promotion Schemes: Suppose the government of Country H introduces a scheme
offering tax incentives and subsidies to exporters of renewable energy products. Under this
scheme, exporters of solar panels and wind turbines receive tax credits and cash subsidies
based on the value of their exports. These incentives encourage exporters to expand their
renewable energy exports and capture market share in the global market.
In summary, banks play a crucial role in financing imports and exports, providing various
financial instruments and facilities to facilitate international trade. Additionally, governments
implement policies and schemes to support exporters and promote a favorable trade
environment.
