presentation on Exchange rate determinations

1. Exchange
Rate
Determination
&
Convertibility
of
Rupee
Presented by
Govardhan
R.no:51
31st P.G.D.M

2. Exchange Rate Determination
THE BRETTON WOODS SYSTEMS OF EXCHANGE RATE’S:
 The Collapse of Gold Standard & Establishment of
International Monetary fund in 1945.
 These leads to New system in exchange rates
is B.W.S.E.R
 In this system each Country was to fix the Par value
of its Currency in terms of GOLD (or) U.S DOLLARS
 Monetary Authorities were allowed to make Adjustment
to extent ±1.0 of the fixed Par value
 This system doing stability in Exchange rate for
Short time only.

3. Exchange Rate Regime Since 1973:
 Due to the Collapse of B.W.S.E.R
 One Committee Appointed by the I.M.F Suggested
Four Options.
a. Floating Rate System
b. Pegging of Currency
c. Crawling Peg
d. Target Zone Arrangement

4. Theories of Exchange Rate Behaviour:
 Balance of Payment Approach
 Monetary Approach
i. Monetary Approach of Flexible Price Version
ii. Monetary Approach of Sticky Price Version
 Portfolio Balance Approach

5. Balance of Payment Approach:
 This theory is proposed by “Allen” and “Kennen”.
 This theory explains Inflow of Foreign exchange takes place under
2 Situations
(a) Export of Goods & services when price in Domestic Country is
Lower compared to foreign Countries.
(b) Foreign investments when the interest rates in Domestic country
are higher than that in Foreign countries.
 Increases inflow of foreign exchange and foreign capital enhances the value
of Domestic Currency against foreign currencies.
 The opposite situation reduces the value of Domestic currency against
foreign currencies.

6. Monetary Approach of Flexible Price Version
 FRENKEL proposed this Theory
 In this approach the exchange rate between 2 currencies is fixed on the basis
of money in the 2 countries.
 Demand for money is positively related to price and output , and is negatively
related to interest rate
 Higher growth rate of supply of money then real output result in decline in
Domestic price and increases in the value of Domestic currency

7. Monetary Approach of Sticky Price Version:
 This theory is proposed for the increases in money Supply results in Decline
in value of Domestic currency
Assumptions:
 (a): money supply in a Country is Positively Related to market
interest Rate
 (b): Purchasing Power praity theory applies in long run and expected
inflation changes influences the exchange rates

8. Portfolio Balance Approach:
 This theory Emphasis the Exchange the exchange rate is determined
based on not only inflow and outflow of Foreign exchange but also holding
of financial Assets like Domestic and Foreign Bonds
 In this Approach the Exchange rate determined on the basis of interaction
of Real income , Interest rates , Risk , Price level and Wealth
 Investor portfolio based on change of this Rates (or) Variables
 Demand for foreign currency reduces the value of foreign currency and
these by exchange rate
 Change in exchange rates bring Corresponding change in Portfolio.

9. Exchange Rate Determination:
 The Transactions in the Foreign exchange market i.e Buying and Selling
Foreign Currency take place at a rate which is called Exchange Rate
 The exchange rate Quote in 2 ways
(1). One unit of Foreign money to a number of units of Domestic currency
(2). A Certain number of units of Foreign Currency to one unit of
Domestic currency
eg: 1 US $ = Rs
 Exchange rate in a Free market is Determined by Demand & Supply of
exchange of a particular Country

10.  Equilibrium exchange rate is rate at which demand and supply of foreign
Exchange are EQUAL
 “RAGNAR NURSKE” defined by Equilibrium exchange rate as “that rate
which over a certain period of time keeps the balance of payments in
equilibrium.”
 Equilibrium exchange rate determined by Two methods
a). The exchange rate between US dollars and Indian Rupees determined
by demand and supply of US dollars by India or Indians
eg: 1US $ = Re 64.02
(b). The exchange rate between Indian Rupees and US dollars determined
by demand and supply by Americans or USA
eg: Re 1 = US $ 0.0156

11. Demand for Foreign Exchange:
 The Demand is determined by the country’s
 Import of goods and services
 Investment in foreign countries
 Payments of Indian Government to various foreign governments for
settlement of their transactions
 Other type of outflow of foreign capital like giving donations etc

12. Supply of Foreign Exchange :
 The supply of foreign exchange includes:
 Country export of goods and services to foreign countries
 Inflow of foreign capital
 Payments made by foreign govt to indian govt
 Other types of inflow of foreign currency like remittances by the
N.R.I’s

13. Fixed and Flexible Exchange System
Fixed exchange rates
 In this system Government fix the exchange rate
 The central bank of country to operate by creating “ Exchange stabilisation
fund”
 The central bank purchases the foreign currency when exchange rate falls
and sells the foreign currency when rate increases.
Flexible Exchange Rate
 Its also called floating or fluctuating exchange
 Its determined by demand and supply of foreign exchange
 These market forces works on their own automatically

14. Convertibility of the Rupee
 The Term convertibility of currency means it can freely converted into any
other currency
Liberalised Exchange Rate Management System
 Under this system 40% of current account transaction conduct at the rate
determined by RBI and remaining 60% at the market determined rate
 This system introduced transitional arrangement towards unified exchange
rate with current account convertibility
 Unified exchange rate
 Current account convertibility
 Capital account convertibility