1

Effects of Foreign
Exchange Rate on Indian
Economy
MOHAMED RIZWAN

PRATIK PARTHE

NAVIN KUMAR
INDRANIL CHOUDHURY
SINGHAL
(Section BKUNAL
PGDM
Batch 2015 2017)
IFIM Business School

Objectives
What is Foreign Exchange Rate and its significance?
Major participants in the Foreign Exchange Market
Types of Foreign Exchange Rates
Key Factors that Affect Foreign Exchange Rates
Role of RBI in Foreign Exchange Markets in India
How does RBI manages exchange rate in the interbank market?
Foreign exchange risk and its types
Advantages of ForEx Market and Summary

What is Foreign
Exchange Rate
and
its significance?

Foreign Exchange rate(ForEx

rate)
Definition:
The rate at which one country's currency may be converted into
another.

It may fluctuate daily with the changing market forces of

supply and demand of currencies from one country to
another.

For these reasons; when sending or receiving money

internationally, it is important to understand what
determines exchange rates.

Foreign Exchange rate(ForEx

rate)

One of the most important means through which a countrys relative

level of economic health is determined.

Provides a window to its economic stability

Sending or receiving money from overseas - a keen eye on the currency

exchange rates.

Main currency used for Forex trading - US dollar

Major currencies of the World

USD (1 USD = 66.64 Rupees)

EURO (1 EURO = 70.61 Rupees)

YEN (I YEN = 0.54 Rupee)

POUND STERLING (1 BRITISH POUND = 99.51 Rupees)

YUAN (1 YUAN = 10.40 Rupees)

7
All Scheduled Commercial Banks (Authorized Dealers only)
Reserve Bank of India (RBI)

Major participants
in the Foreign
Exchange Market

Corporate Treasuries
Public Sector/Government
Inter Bank Brokerage Houses
Resident Indians / Non Residents
Exchange Companies / Money Changers

Types of
Foreign
Exchange
Rates

Types of Foreign exchange rates

Foreign exchange rates

Fixed Exchange Rate System

(System in which exchange rate for a
currency is fixed by the government)

Flexible Exchange Rate System

(System in which exchange rate is
determined by forces of demand and
supply of different currencies in the
foreign exchange market)

10

What are the

key factors
that affect
Foreign
Exchange
Rates?

Key Factors
that Affect
Foreign
Exchange
Rates

1
1

12

Inflation Rates

Indian economy is relatively inflationary

Higher inflation rate increases the prices of Indian goods & services

Due to which the demand for Indian goods decreases in the international
market

Less demand for goods results in less demand for Indian Rupee

Subsequently Indian rupee depreciates against foreign currencies like US

Dollar, Euro etc.

Source:

14

Interest Rates

Changes in interest rate affect currency value and dollar exchange rate.

Forex rates, interest rates, and inflation are all correlated.

Increases in interest rates cause a country's currency to appreciate

because higher interest rates provide higher rates to lenders, thereby
attracting more foreign capital, which causes a rise in exchange rates.

15

Government Debt

Public debt or national debt owned by the central government.

A country with government debt is less likely to acquire foreign capital,

leading to inflation.

Foreign investors will sell their bonds in the open market if the market
predicts government debt within a certain country.

As a result, a decrease in the value of its exchange rate will follow.

16

Recession

When a country experiences a recession, its interest rates are likely to

fall, decreasing its chances to acquire foreign capital.

As a result, its currency weakens in comparison to that of other

countries, therefore lowering the exchange rate.

Countrys Current Account /

Balance of Payments

A countrys current account reflects balance of trade and earnings on

foreign investment.

It consists of total number of transactions including its exports, imports,

debt, etc.

A deficit in current account due to spending more of its currency on

importing products than it is earning through sale of exports causes
depreciation.

Balance of payments fluctuates exchange rate of its domestic currency.

17

18

Terms of Trade

Related to current accounts and balance of payments, the terms of trade

is the ratio of export prices to import prices.

A country's terms of trade improves if its exports prices rise at a greater

rate than its imports prices.

This results in higher revenue, which causes a higher demand for the
country's currency and an increase in its currency's value.

This results in an appreciation of exchange rate.

Political Stability &

Performance

19

A country's political state and economic performance can affect its currency strength.

A country with less risk for political turmoil is more attractive to foreign investors, as
a result, drawing investment away from other countries with more political and
economic stability.

Increase in foreign capital, in turn, leads to an appreciation in the value of its

domestic currency.

A country with sound financial and trade policy does not give any room for
uncertainty in value of its currency.

But, a country prone to political confusions may see a depreciation in exchange rates.

20

Speculation

If a country's currency value is expected to rise, investors will demand more of

that currency in order to make a profit in the near future.

As a result, the value of the currency will rise due to the increase in demand.

With this increase in currency value comes a rise in the exchange rate as well.

21

Role of RBI in
Foreign
Exchange
Markets in
India

Role of RBI in Foreign

Exchange Markets in India

22

Post independence, Indias exchange rate was fixed by the RBI against
Pound sterling

Exchange rate changed to dollars and then to a basketof currencies

1993 - Liberalized Exchange Rate Management System(LERMS)

1999 - Market-determined exchange rate (MDER)

Market Stabilization Scheme (MSS)

Fundamentals Of Central
Bank Intervention
A.

Role of Exchange Rates:

Links between the domestic
and the World economy

23

Fundamentals Of Central
Bank Intervention
B.

The impact of exchange rate changes

1.

Currency Appreciation:

Domestic prices increase relative to foreign prices.

Exports: less competitive

Imports: more attractive

Currency Depreciation

2.

domestic prices fall relative to foreign prices.

Exports: more competitive.

Imports: less attractive

24

Fundamentals Of Central
Bank Intervention

25

Impact of Exchange rate on

Exports

26

Fundamentals Of Central
Bank Intervention
C.

Foreign Exchange Market Intervention

1.

Definition: The official purchases and sales of currencies

through the central bank to influence the home exchange rate.

2.

Goal of Intervention: to alter the demand for one currency by

changing the supply of another.

27

28

What affects a Currencys value?

Current events

Current supply

Demand flows

Expectation of future exchange rate

29

Foreign
exchange risk
and its types

30

Foreign Exchange Risk

The risk of an investment's value changing due to changes in currency

exchange rates.

The risk that an investor will have to close out a long or short position
inaforeign currency at a lossdue to an adverse movement in
exchange rates.

Also known as "currency risk" or "exchange-rate risk".

31

Foreign Exchange Risk

This risk usually affects businesses that export and/or import.

Also, affect investors making international investments.

Types of Risk From Foreign

Exchange Exposure

32

Transaction Risk
When a firm or individual has a receivable or a payable in a foreign
currency; the foreign exchange rate may change, causing an increase
in the liability of the home country's currency or a decrease in
receipts in the home country's currency.

Translation Risk
When a home country entity is required to consolidate its foreign
subsidiaries' income statements and balance sheets into the home
currency. Exchange rates may change, causing an increase in
liabilities or a decrease in assets as measured in home country
currency terms.

Economic Risk
The effect of exchange rate changes on the long term expected
income streams, i.e., expected net wealth of home country
stockholders. This risk is usually managed with physical location of
assets and liabilities.

How Foreign Exchange Risk

is measured?

36

Variance (or) standard deviation of a variable such as percentage returns or rates of

change

Variance - exchange rate risk by the spread of exchange rates

Standard deviation - exchange rate risk by the amount exchange rates deviate,
on average, from the mean exchange rate in a probability distribution

Higher the standard deviation - greater the currency risk

Value at Risk (VAR) - financial risk management technique

Foreign exchange hedging strategies - to reduce the exchange rate risk

Foreign Exchange Management

Act
Foreign Exchange Management Act, 1999(FEMA) - "to
consolidate and amend the law relating to foreign exchange
with the objective of facilitating external trade and payments
and for promoting the orderly development and maintenance
of foreign exchange market in India".

37

38

Advantages of
Forex Market
and

Summary

39

Advantages of Forex Market

Worlds largest market and its still growing quickly

Extensive use of information technology making it available to everyone

Traders can profit from both strong and weak economies

The market is open 24 hours a day during weekdays

40

Facts and Questions to think?

Currently, What is the rank of Indian economy in terms of PPP?

What do you mean by Price maker Vs. Price Taker?

How does RBI create foreign exchange reserves when India has a trade
deficit always? Is it advisable for RBI to depreciate Rupee when the
country is not an export driven economy? How does it affect the
majority people of the country?

41

Summary

Foreign Exchange Rate - The rate at which one country's currency may be
converted into another.

Types of Foreign Exchange Rate Fixed/Flexible

Role of RBI - manage the volatility and disruptions to the macro economic situation

Foreign Exchange Risk - The risk of an investment's value changing due to changes
in currency exchange rates.

Transaction Risk / Translational Risk / Economic Risk

Foreign Exchange Management Act, 1999

42

References

http://www.gktoday.in/blog/role-of-rbi-in-foreign-exchange-markets-in-india/

https://en.wikipedia.org/wiki/Foreign_exchange_risk

https://www.quora.com/How-does-RBI-create-foreign-exchange-reserves-whenIndia-has-a-trade-deficit-always-Is-it-advisable-for-RBI-to-depreciate-Rupeewhen-the-country-is-not-an-export-driven-economy-How-does-it-affect-themajority-people-of-the-country

43

Any Questions?