KANDIVLI EDUCATION SOCIETY’S BK SHROFF COLLEGE OF

ARTS & MH SHROFF COLLEGE OF COMMERCE

“Business Economics-II

“Foreign Exchange Market”

A Project Submitted in Partial Fulfilment of the Requirements For

Semester IV of the B.M.S. Course.

Date of Submission – 1st February 2021

Teacher In-Charge – Miss Blesse

Himani Shah
SYBMS – B
Roll No- 45
Phone. No. 9769077928
Gmail: [email protected]
Index
Sr. No Topic Name Page Number
1 What is foreign 2
exchange market
(introduction)
2 Understanding foreign 2
exchange market
3 Foreign exchange 4
market in India
4 Functions of foreign 5
exchange market
5 Types of foreign 6
exchange market
6 Dealers in foreign 7
exchange market
7 Spot exchange rate 8
8 Forward exchange rate 10
9 Hedging, speculation, 10
arbitrage.
10 4 ways to determine the 12
rate of foreign exchange
11 History of Indian 14
foreign exchange market
12 Recommendation of 15
expert group on foreign
exchange market
13 Conclusion 17
INTRODUCTION
What Is the Foreign Exchange Market?
The foreign exchange market (also known as forex, FX, or the currency
market) is an over-the-counter (OTC) global marketplace that determines
the exchange rate for currencies around the world. Participants are able
to buy, sell, exchange, and speculate on currencies.

Foreign exchange markets are made up of banks, forex dealers,

commercial companies, central banks, investment management
firms, hedge funds, retail forex dealers, and investors.

 The foreign exchange market is an over-the-counter (OTC) marketplace

that determines the exchange rate for global currencies.

 It is, by far, the largest financial market in the world and is comprised of a
global network of financial centres that transact 24 hours a day, closing
only on the weekends.

 Currencies are always traded in pairs, so the "value" of one of the

currencies in that pair is relative to the value of the other.

Understanding the Foreign Exchange Market

The foreign exchange market—also called forex, FX, or currency market—was
one of the original financial markets formed to bring structure to the burgeoning
global economy. In terms of trading volume, it is, by far, the largest financial
market in the world. Aside from providing a venue for the buying, selling,

exchanging, and speculation of currencies, the forex market also enables

currency conversion for international trade settlements and investments.
According to the Bank for International Settlements (BIS), which is owned by
central banks, trading in foreign exchange markets averaged $6.6 trillion per day
in April 2019.1

Currencies are always traded in pairs, so the "value" of one of the currencies in
that pair is relative to the value of the other. This determines how much of
country A's currency country B can buy, and vice versa. Establishing this
relationship (price) for the global markets is the main function of the foreign
exchange market. This also greatly enhances liquidity in all other financial
markets, which is key to overall stability.

The value of a country's currency depends on whether it is a "free float" or "fixed

float". Free-floating currencies are those whose relative value is determined by
free market forces, such as supply-demand relationships. A fixed float is where a
country's governing body sets its currency's relative value to other currencies,
often by pegging it to some standard. Free-floating currencies include the U.S.
dollar, Japanese yen, and British pound, while examples of fixed floating
currencies include the Chinese Yuan and the Indian Rupee.

One of the most unique features of the forex market is that it is comprised of a
global network of financial centers that transact 24 hours a day, closing only on
the weekends. As one major forex hub closes, another hub in a different part of
the world remains open for business. This increases the liquidity available in
currency markets, which adds to its appeal as the largest asset class available to
investors.

The most liquid trading pairs are, in descending order of

liquidity:
EUR/USD

USD/JPY

GBP/USD

Forex Leverage

The leverage available in FX markets is one of the highest that traders and
investors can find anywhere. Leverage is a loan given to an investor by their
broker. With this loan, investors are able to increase their trade size, which could
translate to greater profitability. A word of caution, though: losses are also
amplified.
For example, investors who have a $1,000 forex market account can trade
$100,000 worth of currency with a margin of 1%. This is referred to as having a
100:1 leverage. Their profit or loss will be based on the $100,000 notional
amount.

Benefits of Using the Forex Market

There are some key factors that differentiate the forex market from others, like
the stock market.

There are fewer rules, which means investors aren't held to the strict standards
or regulations found in other markets.

There are no clearing houses and no central bodies that oversee the forex
market.

Most investors won't have to pay the traditional fees or commissions that you
would on another market.

Because the market is open 24 hours a day, you can trade at any time of day,
which means there's no cut-off time to be able to participate in the market.

Finally, if you're worried about risk and reward, you can get in and out whenever
you want, and you can buy as much currency as you can afford based on your
account balance and your broker's rules for leverage.

Foreign Exchange Market in India

The foreign exchange market in India started when in 1978 the government
allowed banks to trade foreign exchange with one another. Foreign Exchange
Market in India operates under the Central Government of India and executes
wide powers to control transactions in foreign exchange.

The market in which international currency trade takes place that is where
foreign currencies are bought and sold simultaneously is called the Foreign
Exchange (Forex) Market. It is the organizational framework within which banks,
merchants, firms, investors, individuals and government exchange foreign
currencies for one another. Foreign Exchange

For example, in India the currency in circulation is called the rupee INR and in
the United States, the currency in circulation is called the US Dollar (USD).

An example of a Forex trade is to sell the Indian rupee while simultaneously

buying the US Dollar.
Forex market has no geographical location, it is electronically linked network and
is open 24 hours a day.

The value for which one currency is exchanged for another or the value of one
currency in terms of another currency is called exchange rate. For example, US
dollar can be bought for 63 INR rupees. This is the exchange rate for Indian
rupees in US dollars.

The foreign exchange market in India started when in 1978 the government
allowed banks to trade foreign exchange with one another. Foreign Exchange
Market in India operates under the Central Government of India and executes
wide powers to control transactions in foreign exchange. The Foreign Exchange
Management Act, 1999 or FEMA regulates the whole Foreign Exchange Market in
India. Before the introduction of this act, the foreign exchange market in India
was regulated by the Reserve Bank of India through the Exchange Control
Department, by the Foreign Exchange Regulation Act or FERA, 1947. Interbank
foreign exchange Trading is regulated by the Foreign Exchange Dealers
Association of India (FEDAI) created in 1958, a self-regulatory voluntary
association of dealers or banks specializing in the foreign exchange activities in
India that regulates the governing rules and determines the commissions and
charges associated with the interbank foreign exchange business. Since 2001,
clearing and settlement functions in the foreign exchange market are largely
carried out by the Clearing Corporation of India Limited (CCIL) that handles
transactions of approximately 3.5 billion US dollars a day, about 80% of the total
transactions.

Functions of Foreign Exchange Market

Definition: Foreign Exchange Market is the market where the buyers and sellers
are involved in the buying and selling of foreign currencies. Simply, the market in
which the currencies of different countries are bought and sold is called as a
foreign exchange market.

The foreign exchange market is commonly known as FOREX, a worldwide

network, that enables the exchanges around the globe. The following are the
main functions of foreign exchange market, which are actually the outcome of
its working:
Functions of Foreign Exchange

 Transfer Function: The basic and the most visible function of foreign
exchange market is the transfer of funds (foreign currency) from one
country to another for the settlement of payments. It basically includes
the conversion of one currency to another, wherein the role of FOREX is to
transfer the purchasing power from one country to another.
For example, If the exporter of India import goods from the USA and the
payment is to be made in dollars, then the conversion of the rupee to the
dollar will be facilitated by FOREX. The transfer function is performed
through a use of credit instruments, such as bank drafts, bills of foreign
exchange, and telephone transfers.

 Credit Function: FOREX provides a short-term credit to the importers

so as to facilitate the smooth flow of goods and services from country to
country. An importer can use credit to finance the foreign purchases. Such
as an Indian
company wants to purchase the machinery from the USA, can pay for the
purchase by issuing a bill of exchange in the foreign exchange market,
essentially with a three-month maturity.
 Hedging Function: The third function of a foreign exchange market is
to hedge foreign exchange risks. The parties to the foreign exchange are
often afraid of the fluctuations in the exchange rates, i.e., the price of one
currency in terms of another. The change in the exchange rate may result
in a gain or loss to the party concerned.
Thus, due to this reason the FOREX provides the services for hedging the
anticipated or actual claims/liabilities in exchange for the forward
contracts. A forward contract is usually a three-month contract to buy or
sell the foreign exchange for another currency at a fixed date in the future
at a price agreed upon today. Thus, no money is exchanged at the time of
the contract.

There are several dealers in the foreign exchange markets, the most important
amongst them are the banks. The banks have their branches in different
countries through which the foreign exchange is facilitated, such service of a
bank is called as Exchange Banks.
Types of Foreign Exchange Market
Broadly, the foreign exchange market is classified into two categories on the
basis of the nature of transactions. These are:

 Spot Market: A spot market is the immediate delivery market,

representing that segment of the foreign exchange market wherein the
transactions (sale and purchase) of currency are settled within two days of
the deal. That is, when the seller and buyer close their deal for currency
within two days of the deal, is called as Spot Transaction.
Thus, a spot market constitutes the spot sale and purchase of foreign
exchange. The rate at which the transaction is settled is called a Spot
Exchange Rate. It is the prevailing exchange rate in the market.
 Forward Market: The forward exchange market refers to the
transactions – sale and purchase of foreign exchange at some specified
date in the future, usually after 90 days of the deal. That is, when the
buyer and seller enter into a contract for the sale and purchase of foreign
currency after 90 days of the deal at a fixed exchange rate agreed upon
now, is called a Forward Transaction.
Thus, the forward market constitutes the forward transactions in foreign
exchange. The exchange rate at which the buyers or sellers settle the
transactions in the forward market is called a Forward Exchange Rate.

Thus, the spot and forward markets are the important kinds of foreign exchange
market that often helps in stabilizing the foreign exchange rate.

Dealers in The Foreign Exchange Market

Important dealers in the foreign exchange market are banks, brokers
acceptance houses, central bank and treasury authorities.

1. Banks:
The banks dealing in foreign exchange have branches (called exchange banks) in
different countries and maintain substantial foreign currency balances in these
branches to serve the needs of their customers.

These branches discount and sell foreign bills of exchange, issue bank drafts,
make telegraphic transfers etc. If a bank has excess foreign currency balances, it
can sell these balances to other banks, foreign currency brokers, and sometimes
to foreign monetary institutions.
Similarly, if an exchange bank has deficit foreign currency balances, the other
banks, the brokers and the foreign monetary institutions become the sources of
foreign currency supply.

2. Brokers:
Banks do not deal directly with one another. They use the services of foreign
exchange brokers. The brokers bring together the buyers and sellers of foreign
exchange among banks. By using the brokers, the banks save time and effort.

If a bank wants to buy or sell foreign exchange, it informs the broker the amount
and the rate of exchange in which it is interested. If the broker succeeds in
carrying out the transaction, he receives a commission from the selling bank.

3. Acceptance Houses:
Acceptance houses also deal in foreign exchange. They accept bills on behalf of
their customers and thus help in foreign remittances.

4. Central Bank and Treasury:

The central bank and the Treasury of a country are also the dealers in foreign
exchange. These institutions may intervene in the exchange market occasionally.
They enter the market both as buyers and sellers to prevent excessive
fluctuations in the exchange rates.

Spot Exchange Rate

What Is the Spot Exchange Rate?
A spot exchange rate is the current price level in the market to directly exchange
one currency for another, for delivery on the earliest possible value date. Cash
delivery for spot currency transactions is usually the standard settlement date of
two business days after the transaction date (T+2).

KEY TAKEAWAYS
 The spot exchange rate is the current market price for changing one
currency directly for another.
  Generally, the spot rate is set by the forex market, but some countries
actively set or influence spot exchange rates through mechanisms like a
currency peg.
 Currency traders follow spot rates to identify trading opportunities not
only in the spot market but also in futures, forwards, or options markets.

Understanding the Spot Exchange Rate

The spot exchange rate is best thought of as how much you would have to pay
in one currency to buy another at this moment in time. The spot exchange rate
is usually decided through the global foreign exchange market where currency
traders, institution and countries clear transactions and trades. The forex
market is the largest and most liquid market in the world, with trillions of dollars
changing hands daily. The most actively traded currencies are the U.S. dollar, the
euro—which is used in many continental European countries including
Germany, France, and Italy—the British pound, the Japanese yen and the
Canadian dollar.

Trading takes place electronically around the world between large, multinational
banks. Other active market participants include corporations, mutual funds,
hedge funds, insurance companies and government entities. Transactions are
for a wide range of purposes, including import and export payments, short- and
long-term investments, loans and speculation.

Some currencies, especially in developing economies, are controlled by the

government that sets the spot exchange rate. For instance, the central
government of China sets a currency peg that keeps the Yuan within a tight
trading range against the U.S. dollar.

Spot Exchange Rate Transactions

For most spot foreign exchange transactions, the settlement date is two
business days after the transaction date. The most common exception to the
rule is the U.S. dollar vs. the Canadian dollar, which settles on the next business
day. Weekends and holidays mean that two business days is often far more than
two calendar days, especially during the Christmas and Easter holiday season.

On the transaction date, the two parties involved in the transaction agree on the
price, which is the number of units of currency A that will be exchanged for
currency B. The parties also agree on the value of the transaction in both
currencies and the settlement date. If both currencies are to be delivered, the
parties also exchange bank information. Speculators often buy and sell multiple
times for the same settlement date; in which case the transactions are netted
and only the gain or loss is settled.

The Spot Market

The foreign exchange spot market can be very volatile. In the short term, rates
are often driven by news, speculation and technical trading. In the long term,
rates are generally driven by a combination of national economic fundamentals
and interest rate differentials. Central banks sometimes intervene to smooth the
market, either by buying or selling the local currency or by adjusting interest
rates. Countries with large foreign currency reserves are much better positioned
to influence their domestic currency's spot exchange rate.

How to Execute a Spot Exchange

There are a number of different ways in which traders can execute a spot
exchange, especially with the advent of online trading systems. The exchange
can be made directly between two parties, eliminating the need for a third party.
Electronic broking systems may also be used, where dealers can make their
trades through an automated order matching system. Traders can also use
electronic trading systems through a single or multi-bank dealing system. Finally,
trades can be made through a voice broker, or over the phone with a foreign
exchange broker.

Forward Foreign Exchange Rate

The agreed-upon exchange rate for a forward contract on a currency. When a
forward contract is made, the parties agree to buy/sell the underlying currency
certain point in the future at a certain exchange rate. The rate is negotiated
directly between the parties, unlike a futures contract, which trades on an
exchange. Partly because there is little secondary market for forward contracts,
determining the forward foreign exchange rate is a zero-sum game: one party
will gain on the contract and one will lose, depending on the movements of the
relevant currencies between the formation of the contract and its maturity.

Structure: An outright forward lock in an exchange rate or the forward rate for
an exchange of specified funds at a future value (delivery) date. Outright
Forward Contract in an NDF a principal amount, forward exchange rate, fixing
date and forward date, are all agreed on the trade date and form the basis for
the net settlement that is made at maturity in a fully convertible currency. At
maturity of the NDF, in order to calculate the net settlement, the forward
exchange rate agreed at execution is set against the prevailing market 'spot
exchange rate' on the fixing date which is two days before the value (delivery)
date of the NDF. The reference for the spot exchange rates i.e., the fixing basis
varies from currency to currency and can be the Reuters or Bloomberg pages.
Non-Deliverable Forward Contract.

The risk involved in dealing in the forward foreign exchange market can be
covered by activities like hedging, speculation and arbitrage.

~ The activities allow the dealers not only to cover the risks involved but also to
earn profit by taking advantage of the forward exchange market.

*HEDGING:
~ Hedging covers the risk arising out of changes in the exchange rate. It is
especially essential for firms having large amounts receivables or commitments
to pay in foreign currencies.

~ The strategy of hedging involves increasing the currency that is likely to

appreciate and decreasing the currency that is likely to depreciate.

~ It also involves decreasing liabilities in the currency that is likely to appreciate

and increasing liabilities in the currency that is likely to depreciate.

*SPECULATION:
~ Speculation involves purchase and sale of foreign exchange in the forwards
market with the intention of making profit by taking advantage of changes in
foreign exchange rates.

~ They speculate on the basis of their own calculation of the difference between
the forward rate and spot rate that may prevail at a future date.

~ Speculators try to minimise their loss by entering in spot and forward

agreements simultaneously.

~ Speculation may have stabilising or destabilising effect.

~ Stabilising speculation refers to purchase of foreign currency when the

domestic price of a foreign currency when the domestic price of a foreign
currency falls with the expectation of its increase in the future.
~ Destabilising speculation refers to sale of foreign currency when the exchange
rate falls with the expectation that it would fall further. This magnifies exchange
rate fluctuations and proves highly disruptive to the international flow of trade
and investment.

*ARBITRAGE:
~ Arbitrage refers to purchase of an asset in a low-price market and its sale in a
higher price market.

~ This process leads to equalisation of price of an asset in all the segments of the
market.

~ Arbitrageurs take advantage of the different exchange rates prevailing in

various foreign exchange markets due to different interest rates.

~ They purchase foreign currency from the foreign exchange market with lower
exchange rate and sell the same in market with a higher exchange rate.

~ Arbitrage is also possible within the country where two banks offer two
different bids and asking rate.

~ When arbitrage involves only two currencies or two countries, it is called two-
point arbitrage. It increases the supply of dearer currency.

4 Ways to Determine the Rate of Foreign

Exchange
Four ways to determine the rate of foreign exchange are:

(a) Demand for foreign exchange (currency) (b) Supply of foreign exchange (c)
Determination of exchange rate (d) Change in Exchange Rate!

In a system of flexible exchange rate, the exchange rate of a currency (like price
of a good) is freely determined by forces of market demand and supply of
foreign exchange.

Expressed graphically the Intersection of demand and the supply curves

determines the equilibrium exchange rate and equilibrium quantity of foreign
currency. This is called equilibrium in foreign exchange market).

Let us assume that there are two countries—India and USA—and the exchange
rate of their currencies, viz., rupee and dollar are to be determined. Presently
there is floating or flexible exchange regime in both India and USA. Therefore,
the value of currency of each country in terms of the other currency depends
upon the demand for and supply of their currencies.

(a) Demand for foreign exchange (currency):

Demand for foreign exchange is caused (I) to purchase abroad goods and
services by domestic residents, (ii) to purchase assets abroad, (iii) to send gifts
abroad, (iv) to invest directly in shops, factories abroad, (v) to undertake foreign
tours, (vi) to make payment of international trade, etc. The demand for dollars
varies inversely with rupee price of dollar, i.e., higher the price, the lower is the
demand. The demand curve in Fig. 10.1 is downward sloping because there is
inverse relationship between foreign exchange rate and its demand.

(b) Supply of foreign exchange:

Supply of foreign exchange conies

(I) when foreigners purchase home country’s (say, India’s) goods and services
through our exports

(ii) when foreigners make direct investment in bonds and equity shares of home
country

(iii) when speculation causes inflow of foreign exchange

(iv) when foreign tourists come to home country

(c) Determination of exchange rate:

This is determined at a point where demand for and supply of foreign exchange
are equal. Graphically, intersection of demand and supply curves determines the
equilibrium exchange rate of foreign currency. At any particular time, the rate of
foreign exchange must be such at which quantity demanded of foreign currency
is equal to quantity supplied of that currency. It is proved with the help of the
following diagram. The price on the vertical axis is stated in terms of domestic
currency (i.e., how many rupees for one US dollar).

The horizontal axis measures quantity demanded or supplied of foreign

exchange (i.e., dollars). In this figure, demand curve is downward sloping which
shows that less foreign exchange is demanded when exchange rate increases
(i.e., inverse relationship). The reason is that rise in the price of foreign exchange
(dollar) increases the rupee cost of foreign goods which makes them more
expensive. The result is fall in imports and demand for foreign exchange.
The supply curve is upward sloping which implies that supply of foreign
exchange increases as the exchange rate increases (i.e., direct relationship).
Home country’s goods (here Indian goods) become cheaper to foreigners
because rupee is depreciating in value.

As a result, demand for Indian goods increases. Thus, our exports should
increase as the exchange rate increases. This will bring greater supply of foreign
exchange. Hence, the supply of foreign exchange increases as the exchange rate
increases which proves the slope of supply curve.

In the Fig. 10.1, demand curve and supply curve of dollars intersect each other at
point E which implies that at exchange rate of OR (QE), quantity demanded and
supplied are equal (both being equal to OQ). Hence, equilibrium exchange rate is
OR and equilibrium quantity is OQ.

(d) Change in Exchange Rate:

Suppose, exchange rate is 1 dollar = Rs 50. An increase in India’s demand for US

dollars, supply remaining the same, will cause the demand curve DD shift to D’D’.
The resulting intersection will be at a higher exchange rate, i.e., exchange rate
(price of dollar in terms of rupees) will rise from OR to OR, (say, 1 dollar = 52
rupees). It shows depreciation of Indian currency (rupees) because more rupees
(say, 52 instead of 50) are required to buy 1 US dollar. Thus, depreciation of
currency means a fall in the price of home currency.

Likewise, an increase in supply of US dollar will cause supply curve SS shift to S’S’
and as a result exchange rate will fall from OR to OR 2. It indicates appreciation of
Indian currency (rupees) because cost of US dollar in terms of rupees has now
fallen, say, 1 dollar = Rs 48, i.e., less rupees are required to buy 1 US dollar or
now Rs 48 instead of Rs 50 can buy 1 dollar. Thus, appreciation of currency
means ‘a rise in the price of home currency.

INDIAN FOREIGN EXCHANGE MARKET:

A HISTORICAL PERSPECTIVE Early Stages: 1947-1977

The evolution of India’s foreign exchange market may be viewed in line with the
shifts in India’s exchange rate policies over the last few decades from a par value
system to a basket-peg and further to a managed float exchange rate system.
During the period from 1947 to 1971, India followed the par value system of
exchange rate. Initially the rupee’s external par value was fixed at 4.15 grains of
fine gold. The Reserve Bank maintained the par value of the rupee within the
permitted margin of ±1 per cent using pound sterling as the intervention
currency. Since the sterling-dollar exchange rate was kept stable by the US
monetary authority, the exchange rates of rupee in terms of gold as well as the
dollar and other currencies were indirectly kept stable. The devaluation of rupee
in September 1949 and June 1966 in terms of gold resulted in the reduction of
the par value of rupee in terms of gold to 2.88 and 1.83 grains of fine gold,
respectively. The exchange rate of the rupee remained unchanged between
1966 and 1971 (Chart VI.1). 6.19 Given the fixed exchange regime during this
period, the foreign exchange market for all practical purposes was defunct.
Banks were required to undertake only cover operations and maintain a ‘square’
or ‘near square’ position at all times. The objective of exchange controls was
primarily to regulate the demand for foreign exchange for various purposes,
within the limit set by the available supply. The Foreign Exchange Regulation Act
initially enacted in 1947 was placed on a permanent basis

Post-Reform Period: 1992 onwards

This phase was marked by wide ranging reform measures aimed at widening
and deepening the foreign exchange market and liberalisation of exchange
control regimes. A credible macroeconomic, structural and stabilisation
programme encompassing trade, industry, foreign investment, exchange rate,
public finance and the financial sector was put in place creating an environment
conducive for the expansion of trade and investment. It was recognised that
trade policies, exchange rate policies and industrial policies should form part of
an integrated policy framework to improve the overall productivity,
competitiveness and efficiency of the economic system, in general, and the
external sector, in particular.

As a stabilisation measure, a twostep downward exchange rate adjustment by 9

per cent and 11 per cent between July 1 and 3, 1991 was resorted to counter the
massive drawdown in the foreign exchange reserves, to instil confidence among
investors and to improve domestic competitiveness. A two-step adjustment of
exchange rate in July 1991 effectively brought to close the regime of a pegged
exchange rate. After the Gulf crisis in 1990-91, the broad framework for reforms
in the external sector was laid out in the Report of the High-Level Committee on
Balance of Payments (Chairman: Rd. C. Rangarajan). Following the
recommendations of the Committee to move towards the market-determined
exchange rate, the Liberalised Exchange Rate Management System (LERMS).

Recommendations of the Expert Group on Foreign

Exchange Markets in India
The Expert Group on Foreign Exchange Markets in India (Chairman: Shri O.P.
Sadhana), which submitted its Report in 1995, identified various regulations
inhibiting the growth of the market. The Group recommended that the
corporates may be permitted to take a hedge upon declaring the existence of an
exposure. The Group recommended that banks should be permitted to fix their
own exchange position limits such as intra-day and overnight limits, subject to
ensuring that the capital is provided/earmarked to the extent of 5 per cent of
this limit based on internationally accepted guidelines. The Group also favoured
fixation of Aggregate Gap Limit (AGL), which would also include rupee
transactions, by the managements of the banks based on capital, risk taking
capacity, etc. It recommended that banks be allowed to initiate cross currency
positions abroad and to lend or borrow short-term funds up to six months,
subject to a specified ceiling. Another important suggestion related to allowing
exporters to retain 100 per cent of their export earnings in any foreign currency
with an Authorised Dealer (AD) in India, subject to liquidation of outstanding
advances against export bills. The Group was also in favour of permitting ADs to
determine the interest rates and maturity period in respect of FCNR (B) deposits.
It recommended selective intervention by the Reserve Bank in the market so as
to ensure greater orderliness in the market. In addition, the Group
recommended various other short-term and long-term measures to activate and
facilitate functioning of markets and promote the development of a vibrant
derivative market. Short-term measures recommended included exemption of
domestic interbank borrowings from SLR/CRR requirements to facilitate
development of the term money market, cancellation and re-booking of
currency options, permission to offer lower cost option strategies such as the
‘range forward’ and ‘ratio range forward’ and permitting ADs to offer any
derivative products on a fully covered basis which can be freely used for their
own asset liability management. As part of long-term measures, the Group
suggested that the Reserve Bank should invite detailed proposals from banks for
offering rupee-based derivatives, should refocus exchange control regulation
and guidelines on risks rather than on products and frame a fresh set of
guidelines for foreign exchange and derivatives risk management. As regards
accounting and disclosure standards, the main recommendations included
reviewing of policy procedures and transactions on an on-going basis by a risk
control team independent of dealing and settlement functions, ensuring of
uniform documentation and market practices by the Foreign Exchange Dealers’
Association of India (FEDAI) or any other body and development of accounting
disclosure standards. Reference: Reserve Bank of India. 1995. Report on Foreign
Exchange Markets in India (Chairman: Shri O.P Sadhana), June. Most of the
recommendations of the Sadhana Committee relating to the development of the
foreign exchange market were implemented during the latter half of the 1990s.
6.28 In addition, several initiatives aimed at dismantling controls and providing
an enabling environment to all entities engaged in foreign exchange
transactions have been undertaken since the mid-1990s. The focus has been on
developing the institutional framework and increasing the instruments for
effective functioning, enhancing transparency and liberalising the conduct of
foreign exchange business so as to move away from micro management of
foreign exchange transactions to macro management of foreign exchange flows
An Internal Technical Group on the Foreign Exchange Markets (2005) set up by
the Reserve Bank made various recommendations for further liberalisation of
the extant regulations.

Reference: Reserve Bank of India. 1995. Report on Foreign Exchange Markets in

India (Chairman: Shri O.P Sadhana), June.

Conclusion:
To sum up, the foreign exchange market structure in India has undergone
substantial transformation from the early 1990s. The market participants have
become diversified and there are several instruments available to manage their
risks. Sources of supply and demand in the foreign exchange market have also
changed in line with the shifts in the relative importance in balance of payments
from current to capital account. There has also been considerable improvement
in the market infrastructure in terms of trading platforms and settlement
mechanisms. Trading in Indian foreign exchange market is largely concentrated
in the spot segment even as volumes in the derivatives segment are on the rise.
Some of the issues that need attention to further improve the activity in the
derivatives segment include flexibility in the use of various instruments,
enhancing the knowledge and understanding the nature of risk involved in
transacting the derivative products, reviewing the role of underlying in booking
forward contracts and guaranteed settlements of forwards. Besides, market
players would need to acquire the necessary expertise to use different kinds of
instruments and manage the risks involved.