International finance 315_v1

INTERNATIONAL FINANCE
Sub Code - 315
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Developed by
Prof. Rahul Shah
On behalf of
Prin. L.N. Welingkar Institute of Management Development & Research

Advisory Board
Chairman
Prof. Dr. V.S. Prasad
Former Director (NAAC)
Former Vice-Chancellor
(Dr. B.R. Ambedkar Open University)
Board Members
1. Prof. Dr. Uday Salunkhe 
Group Director 
Welingkar Institute of
Management
2. Dr. B.P. Sabale 
Chancellor, D.Y. Patil University,
Navi Mumbai 
Ex Vice-Chancellor (YCMOU)
3. Prof. Dr. Vijay Khole 
Former Vice-Chancellor 
(Mumbai University)
4. Prof. Anuradha Deshmukh 
Former Director 
(YCMOU)
Program Design and Advisory Team
Prof. B.N. Chatterjee
Dean – Marketing
Welingkar Institute of Management, Mumbai
Mr. Manish Pitke
Faculty – Travel and Tourism
Management Consultant
Prof. Kanu Doshi
Dean – Finance
Dean – Marketing
Prof. Dr. V.H. Iyer
Dean – Management Development Programs
Mr. Smitesh Bhosale
Faculty – Media and Advertising
Founder of EVALUENZ
Dean – Marketing
Prof. Vineel Bhurke
Faculty – Rural Management
Prof. Venkat lyer
Director – Intraspect Development
Dr. Pravin Kumar Agrawal
Faculty – Healthcare Management
Manager Medical – Air India Ltd.
Prof. Dr. Pradeep Pendse
Dean – IT/Business Design
Mrs. Margaret Vas
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Former Manager-Catering Services – Air India Ltd.
Prof. Sandeep Kelkar
Faculty – IT
Mr. Anuj Pandey
Publisher
Management Books Publishing, Mumbai
Prof. Dr. Swapna Pradhan
Faculty – Retail
Course Editor
Prof. Dr. P.S. Rao
Dean – Quality Systems
Prof. Bijoy B. Bhattacharyya
Dean – Banking
Dean – Marketing
Mr. P.M. Bendre
Faculty – Operations
Former Quality Chief – Bosch Ltd.
Course Coordinators
Prof. Dr. Rajesh Aparnath
Head – PGDM (HB)
Mr. Ajay Prabhu
Faculty – International Business
Corporate Consultant
Ms. Kirti Sampat
Assistant Manager – PGDM (HB)
Mr. A.S. Pillai
Faculty – Services Excellence
Ex Senior V.P. (Sify)
Mr. Kishor Tamhankar
Manager (Diploma Division)
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1st Edition (July-2006). 2nd Edition (Jan-2011). 3rd Edition (Jan-2013)
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CONTENTS
Contents
Chapter No. Chapter Name Page No.
1 Overview of International Business 3-18
2 Fundamentals of International Finance 19-39
3 International Foreign Exchange Markets 40-60
4 Foreign Exchange Management in India 61-72
5 Foreign Exchange Quotations 73-123
6 Foreign Exchange Calculations 124-177
7 Exchange Rate Regimes 178-199
8 Euro Currency (Offshore) Market 200-220
9 International Equity Market 221-243
10 Risk Management and Derivatives 244-260
11 International Institutions 261-273
12 Appendix 274-279
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OVERVIEW OF INTERNATIONAL BUSINESS
Chapter 1
Learning Objectives
After completing this chapter, you should be able to understand:
• What is International Business (IB)
• How Globalization Impacts the Economy on the Backdrop of IB
• International Bank for Reconstruction and Development (IBRD) and its
Impact
• Role and Importance of World Bank
• Components of International Business
• Contribution of International Finance
Structure:
1.1 Introduction
1.2 Introduction of International Business
1.3 Growing Importance of International Business
1.4 International Bank for Reconstruction and Development (IBRD) and its
impact
1.5 Drivers of International Business
1.6 Nature of International Finance
1.7 Significance of International Finance
1.8 Summary
1.9 Self Assessment Questions
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1.1 INTRODUCTION
One of the most significant trends in past two decades has been the rapid
and sustained growth of international business in the world. Markets have
become truly global for most of the goods, services and financial
instruments. World trade has expanded by more than six per cent per year
since 1950. The most dramatic increase in globalization has occurred in
financial markets. Global markets are characterized by competition. More
and more companies are going international and a growing percentage of
their overall sales is coming from overseas markets. There are new
opportunities and pressures to utilize them. The opening of markets
creates new geographical space for companies to expand in and access
tangible and intangible resources. It also permits wider choice in the
methods like trade, FDI, licensing, sub-contracting, franchising and
partnering to operate in different locations.
Today, more and more companies from many countries are investing
abroad through mergers and acquisitions or through various forms of non-
equity relationships. The fragmentation and production processes across
international borders are an important new trend for developing
economies. Global trade rules have fostered global production networks
and an associated rise in intra firm trade by progressively lowering trade
barriers. Foreign capital has played a catalytic role in pushing policies in
the right direction and controlling number of resources to the development
effort. Globalization is praised for the new opportunities such as access to
new markets and technology transfer, increased production and higher
living standards. There is wide spread reduction and removal of trade
barriers, deregulation of internal markets, privatization and liberalization of
technology and investment flows at national level. Thus, it appears that in
the changing economic scenario, global business is a fact of like. The global
corporations have become the central players of the world economy and in
linking foreign direct investment, trade technology and finance. They are a
driving force of world growth. Managing business is the new millennium
means some global interactions. The companies may succeed or fail on the
basis of their ability to deal with the dynamic global environment. Their
impact on the economic and the social welfare of developing countries is
both widespread and critical.
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1.2 INTRODUCTION OF INTERNATIONAL BUSINESS
International business is the process of focusing on the resources of the
World and objectives of the organizations on World business opportunities
and threats. The term international business has emerged from the term
export marketing. A company that fails to go global is in the danger of
losing its domestic business to competitors with lower costs, greater
experience better products and, in a nutshell MORE VALUE for the
customer.
Globalization makes the business environment increasingly global even for
domestic firms. The major competition which many firms encounter in the
home market now, for instance, is from foreign firms - they now face a
substantially growing competition from goods produced in India by MNC
and imports.
For the sake of simplicity, one may be tempted to define international
business as any business activity or transaction that transcends the
national border. It is however, doubtful whether some of the business
transactions which cross national border can be regarded as real
international business. For example, consider the case of a firm which
imports a minor item, which is not available domestically and is required
for manufacturing from a foreign country. The nature and reason/purpose
of business activities which cross national borders differ, and therefore, the
extent of real internationalization or international orientation also differs. It
may also be noted that there may be real internationalization in certain
transactions which would outwardly appear to be purely domestic business.
For example, take the case of a firm which sells all its output domestically
and procures all the raw materials, parts, components and other industrial
inputs domestically. There is real internationalization, if the procurement
from the domestic market is the result of global sourcing, i.e., the decision
to source them domestically is the result of the realization that the current
global sourcing destination is globally the best source. Some other facets of
internationalization of what may appear to be domestic business is
indicated in the definition of international marketing.
It may be noted that many seemingly domestic products are truly
international products in the sense that several of the parts and
components which make up these products are manufactured in different
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countries as mentioned earlier and explained in this section on global
sourcing and production sharing.
1.3 GROWING IMPORTANCE OF GLOBALISATION OF
INTERNATIONAL BUSINESS
The importance of international business is due to following driving forces:
Liberalization
One of the most important factors which have given a great impetus to
internationalization since the 1990s, is the almost universal economic
policy liberalisations which are fostering a borderless business world. While
a lot of the liberalizations owe it to the GATT/WTO, substantial
liberalizations have been occurring outside the GATT/WTO as well for
example, the revolutionary economic policy changes in China and other
Socialist/ Communist nations. It may be noted that it has become quite
common to describe the global trend as LPG (Liberalization, Privatization
and Globalization) is indicating the mutually interdependent and reinforcing
nature of these forces.
Multinational Companies
Multinational enterprises which link their resources and objectives with
world market opportunities have been a powerful driving force targeting
globalization. Taking advantage of the liberalization trend, there has been a
fast growth of the number of MNCs and their global network of affiliates.
Accordingly to the World Investment Report, 1997, there were about
44,500 MNCs (it would definitely be more than 70,000 in the year 2007).
According to World Investment Report, 2002, the MNCs were 65,000. The
MNCs leverage their strengths to link global resources and opportunities
and thereby, strengthen the globalization trend.
Technology Development
Technological advances have tremendously fostered globalization.
Technology has in fact been a very important facilitating factor of
globalization, with its rising costs and risks, which makes it imperative for
firms to tap world markets and to share these costs and risks on the other
hand, falling transport and communication costs — the death of distance
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have made it economical to integrate distant operations and ship products
and components across the globe in the search of efficiency. Technology is
a universal factor that crosses national cultural boundaries. Technology is
truly STATELESS, there are no cultural boundaries limiting its application.
Once a technology is developed, it soon becomes available everywhere in
the world. Monopoly of technology, like possession of patented technology,
encourages internationalization because the firm can exploit the respective
demand without any competition. For example, a hospital in the U.S.
performs the required diagnostics - an Xray and assorted scans. In the
next three minutes, a radiologist in Bengaluru (India) receives the scanned
images and sends back his report (teleradiology). The entire process from
the time the patient got admitted, takes 20 minutes. The cost of this work
is over 30% lower in India compared to U.S.A and the time difference
makes it easier for them to look for India (an article on long range X-ray,
published in Business Today, Oct 13, 2002).
Transportation and Communication Revolution
The IT revolution has made an enormous contribution to the emergence of
the global village. Indeed the microprocessor, which enabled the explosive
growth of high power, low cost computing, vastly increasing the amount of
information that can be processed by individuals and firms, has been doing
wonders. The microprocessor also underlies many recent advances in
telecommunications technology. The development in satellite, optical fiber,
wireless technologies and Internet and world wide web (www) has been
revolutionized. The cost of microprocessors continues fall, while their
power increases (doubles) and its cost of production falls in half every 18
months (this is known as Moore's Law). The internet and web have
increased the volume of global business from fewer than one million users
in 1990, connected to the Internet and increased to 1.12 billion users or
about 18% of the world population by the end of the year, 2005.
Global sourcing was increased not only by trade liberalization but also by
technological developments which reduced transport costs. Advent of
containerization and super tonnage cargo ships drastically reduced
transport costs.
Product Development Costs and Efforts
The cost of new product development is very huge in several industries
such as pharmaceuticals. To recoup such high costs an international market
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is required. Further, because of the huge investment and diverse
requirements of skill associated with new product development, cross
border alliances in research and development are becoming more and
more popular.
Quality and Cost
The two most important determinants of demand are the quality and price
of the offering.These are better achieved when the firm/company is
international in its operations.
Rising Aspirations and Wants
Due to increasing level of education and exposure to the electronic-media,
the aspirations of people all around the world are rising. The customer
today is by and large international he/she wants a world-class products of
a desired attributes at international price. He/She may desire a product
available anywhere in the world.
Competition
Another factor for importance of international business is increasing
competition.Heightened competition compels firms to explore new ways of
increasing their efficiency, including by extending their international reach
to new markets at an early stage. With new ownership and contractual
arrangements, and new activities being located in new sites abroad.
World Economic Trends
One of the important trends is the difference in the growth rates of the
economies/markets. The comparative slow growth of the developed
economies or the stagnation of some of their markets and the fast growth
of a number of developing countries, prompt firms of developed-countries
to turn to the expanding markets, elsewhere.
The domestic economic growth and the outside opportunities reduce the
opposition to international business.
Another driving force of internationalization is the economic liberalization,
characterised by DEREGULATION and PRIVATISATION.
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Regional Integration
The proliferation of regional integration schemes, like the European Union
(EC), North American Free Trade Agreement (NAFTA), SAARC, ASEAN, EEC,
EFTA (European Free Trade Association), etc. by creating a borderless
world between the members of such trade blocs, foster the
internationalization trend. Many of these regional blocs also give a fillip to
the cross border investments and financial flows.
Development of Leverages
Leverage is simply some type of advantage that a company enjoys by
virtue of the fact that it conducts business in more than one country any
international company posseses the four important leverages.
a. Experience transfer for expanding or strengthening its
international operations: It can draw on management practices,
strategies, products, advertising,appeals or sales or promotional ideas
that have been tested in actual markets and apply them in other
comparable markets
b. Scale economies: The cost is one of the important determinants of
success. Cost advantage, in many cases, derives out of scale
economies. To realize scale economies, it is often essentital to go after
the global market. Technological breakthroughs are substantially
increasing the scale economies and the market scale required to break-
even.
c. Resource utilization: Another strength of an international company is
its competence of sourcing the resources internationally.
d. International strategy: A global strategy built on an information
system that scans the world-business environment to identify
opportunities, trends, threats and resources. The international strategy
is a design to create a winning offering on an international scale.
To Achieve Higher Rate of Profits
When the domestic markets do not promise a higher rate of profits,
business firms search for foreign markets which promise for higher rate of
profits.
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Expansion of Production
Many of the domestic companies expanded their production capacities that
was more than the domestic demand. These companies in such cases are
forced to sell their excess production in foreign developed countries. Toyota
Motors of Japan is an example
Limited Home Market
When the size of the home market is limited either due to the smaller size
of population or due to lower purchasing power of the people or both, the
companies internationalise their products. ITC entered the European
market due to lower purchasing power of the Indians with regard to high
quality cigarettes.
Similarly, merely 60 lakh population of Switzerland forced Ciba-Geigy to
internationalise its operations. In fact, this company was forced to
concentrate on international market and establish manufacturing facilities
in foreign countries including India.
Political Stability
Political stability does not simply mean that continuation of the same party
in power, but that continuation of the same policies of the Government for
a quite longer period. Business firms prefer to enter the politically stable
countries and are restrained from locating their business operations in
politically instable countries.
Nearness to Raw Materials
The source of highly qualitative raw materials and bulk raw materials is a
major factor for attracting the companies from various foreign countries.
Most of the U.S.-based and European-based companies located their
manufacturing facilities in Saudi Arabia, Bahrain, Qatar, Oman, Iran and
other middle-east countries due to the availability of petroleum.
Quality of Human Resource Availability
This is a major factor for software, high technology and telecommunication
companies to locate their operations in India. Importing human resources
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from India by these companies is costly rather than locating their
operations in India.
Imposition of Tariffs and Quotas
Before deregulation and globalization there were various governments
which imposed tariffs or duty on imports to protect the domestic company.
Government had also fixed import quotas in order to reduce the
competition to the domestic companies from foreign companies. These
practices are still prevalent not only in the developing countries but also in
advanced countries. For example, Japanese companies are competent
competitors to the US companies. U.S.A., imposed tariffs and quotas
regarding import of automobiles and electronics from Japan. Harley-
Davidson of U.S.A., sought and got 5 years of tariffs protection from
Japanese imports. To avoid high tariffs and quotas, companies prefer direct
investment to go to internationally. For example, companies like Sony,
Honda, and Suzuki preferred direct investment in various countries by
establishing subsidiaries or through joint ventures.
1.4 INTERNATIONAL BANK FOR RECONSTRUCTION AND
DEVELOPMENT (IBRD)
The World Bank originated as a result of the Bretton Woods Conference of
1944, is one of the World's largest sources of development assistance and
its extended assistance to more than 100 developing nations, bringing a
mix of finance and ideas to improve living standards and eliminate the
worst forms of poverty. For each of its clients, the IBRD works with
government agencies, non-governmental organizations and the private
sector to formulae assistance strategies.
The World Bank group comprises of five closely associated institutions,
each institution playing a distinct role in the mission to fight poverty and
improve living standards for people in the developing world. The term
World Bank refers specially to two of the five institutions. The IBRD, IDA
(International Development Association), other institutions are the
International Finance Corporation (IFC), the Multilateral Investment
Guarantee Agency (MIGA) and the International Centre for Settlement of
Investment Disputes (ICSID)
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Mission and Role of World Bank
• To fight poverty with passion and professionalism for lasting results.
• To help people, help themselves and their environment by providing
resources sharing knowledge, building capacity and forging partnerships
in the public and private sectors.
• To be an excellent institution, able to attract, excite and nurture diverse
and committed staff with exceptional skills who know how to listen and
learn.
• To assist in the reconstruction and development of the territories of the
members, by facilitating the investment of capital for productive
purposes, including the restoration of economies destroyed or disrupted
by war, the reconversion of productive facilities to peace time needs and
the encouragement of the development of the productive facilities and
resources in less developed countries.
• To promote private foreign investment by means of guarantees or
participation in loans and other investments made by private investors,
and when private capital is not available on reasonable terms to
supplement private investment by providing, on suitable conditions,
finance for productive purposes out of its own capital funds raised by it
and other resources.
• To promote the long-range balanced growth of international trade and
the maintenance of equilibrium in the balance of payments by
encouraging international investment of the productive resources of
members, thereby, assisting in raising productivity, the standards of
living and conditions of labour in the territories.
• To make sure of availability of funds in the market.
• To provide funds to the borrowers at the possible lowest cost through
manipulating the currency mix and opting the time when the interest rate
in the market is low.
• To control volatility in net income and overall charges of the loan.
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• To promote an appropriate degree of maturity transformation between
borrowings and lending.
• It borrows in the international capital market both on medium and long-
term basis, on currency swaps and under the discount net programme.
Implications
• Funds contribute directly to productive capacity projects.
• Indirectly promotion of local private enterprises.
• Investments directly affect the well-being of the masses of poor people
of developing countries.
• Energy development through oil and gas.
• Contribution to a more sustainable balance of payments in the medium
and longterm and to the maintenance of growth in the face of severe
constraints.
• Through high priority projects needed to restore credit worthiness and
growth.
1.5 DRIVERS OF INTERNATIONAL BUSINESS
International business is not a new phenomenon. Trade across the globe is
as old as business itself. However, the volume of international trade and
the number of players in it have increased dramatically over the last
decade. Today every nation and an increasing number of companies buy
and sell goods in the international marketplace. A number of developments
around the world have helped to fuel this activity. The key drivers of
international business are as follows:
International Production and Operations Management
The globalization process with its borderless network of operations has
created a complex system of manufacturing and operations management
that is indifferent to where goods are manufactured, where services are
offered and where these goods and services are distributed. The dynamic
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shift in the world over in the last decade has resulted in China becoming
the manufacturing center of the world and India becoming the information
technology hub of the world. As international companies seek cost
advantages to compete successfully in the international marketplace, they
constantly look for countries that have lower input costs. In addition, the
technological advances achieved during the late twentieth century have
helped companies adopt more advanced manufacturing systems, including
lean manufacturing. Lean manufacturing improves productivity through
cost and time management. The growth in globalization has opened
opportunities for small entrepreneurs in many countries. Many of these
small entrepreneurs use modern management and operations concepts and
extended value chain management practices to be competitive.
International Marketing
International marketing includes the marketing of goods and services
across national boundaries and the marketing operations of an organization
that sells or produces within a given country when that organization is part
of an enterprise which also operates in other countries and there is some
degree of influence or control of the organizations marketing activities from
outside the country in which it sells and produces the goods. On other
hand,international marketing is simply an attitude of mind and the
approach of a company with a truly global outlook, seeking its profits
impartially around the world. It includes, home market also on a planned
and systematic basis. Thus, developing marketing programs for
international markets is useful to know the various regulations that govern
the activities.
International Human Resource Management
Managing a modern day international company with its dynamic
competitive environment requires a strong internal governance process
that starts with the people that administer it. As more and more companies
embrace the resources- based view (RBV) of strategy, the employees offer
the core competencies for sustainable competitive advantage. Moreover,
research studies have shown that the companies most effective in
conducting business globally must excel in people management among
other factors. Human resources also referred to as human capital are
probably the most important resource the international companies possess.
Thus, as companies grow the need to staff this growth requires that an
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international company recruit and train new employees. Many of the larger
international companies plan their staffing needs well in advance to
coincide with their expansion plans into overseas markets.
International Financial Management
When a company expands its business beyond its national borders by
exporting or importing goods or services, the company's financial manager
has to deal with additional variables such as exchange rates, tariffs, and
regulatory, legal and cultural issues. The financial manager's
responsibilities increase further when the company establishes subsidiaries
abroad, as he or she must deal with additional issues such as borrowing
and lending in local markets and interacting with foreign governments,
agencies and institutions. The international finance manager takes major
decisions about sourcing and investment of funds from various institutions
in the market place such as banks, insurance, stocks, debt markets and
regulatory agencies. Understanding the roles and structures of these
institutions, which are integral to overseas business transactions that help
international financial managers appreciate the decision making challenges
facing them.
1.6 NATURE OF INTERNATIONAL FINANCE
The term "foreign exchange" basically refers to buying the currency of one
country while selling the currency of another country. All nations have their
own, different kinds of money (currency). This has existed throughout the
ages, probably since the time of the Babylonians. As trading developed
between nations, the need to convert one kind of money to another also
developed. This is how a formal system of foreign exchange arose.
As trade between nations developed, Britain, as the nation with the largest
and the strongest navy could spread its commercial interests far and wide.
It therefore, became the most active trading nation, with a vast empire of
colonies. As a result, Britain's currency, the pound sterling, became
benchmark to other currencies that were compared (and exchanged) for
most of the seventeenth, eighteenth and nineteenth centuries. Today, most
currencies are compared to the U.S. Dollar, currently the most active and
commercially strong trading nation; many currencies are still "pegged" to
the U.S. Dollar for their exchange rate.
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Thus, Foreign Exchange refers to money denominated in the currency of
another nation or group of nations. Any person who exchanges money
denominated in one nation’s currency for money denominated in another
nation's currency is conducting foreign exchange. That holds true whether
the amount of the transaction is equal to a few dollars or to billions of
dollars; whether the person involved is a tourist cashing traveler's check in
a restaurant abroad or an investor exchanging hundreds of millions of
dollars to acquire a foreign company. In other words, a foreign exchange
transaction is a shift of funds from one country and currency to another.
The Forex (short for Foreign Exchange) market is the 24 hour cash market
where currencies are traded, typically via brokers. Foreign currencies are
constantly and simultaneously bought and sold across local and global
markets and traders' investments increase or decrease in value based on
currency movements.
Foreign exchange market operates by trading one type of currency against
another. Unlike other financial markets, the market has no physical location
and no central exchange. It operates through a global network of banks,
financial institutions and individuals. The Forex market is emerging as the
world's largest financial market, operating round the clock with enormous
amounts of money traded on a daily basis.
Forex market exists because people and corporate transact internationally.
They travel, export, import goods and services, raise capital abroad and
merge acquire international businesses.
1.7 SIGNIFICANCE OF INTERNATIONAL FINANCE
International Finance is an important input in the decision making process
of different entities. It affects all aspects of economic activity. The activity
can be in the form of individuals making asset selection decisions, firms
taking financial management decision, fund managers deciding on which
markets to deploy funds in and when to exit the markets, governments
deciding to raise funds, central banks dealing with a consistent decline in
foreign exchange reserves, a financial crisis, a surplus of foreign exchange
reserves, or commercial banks making asset liability decisions. In other
words International Finance is also meant as a subset of International
Business.
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1.8 SUMMARY
International Business is the process of focusing on the resources of the
world and the objectives of the organization on world business
opportunities and threats. The term International Business has emerged
from the term international marketing which in turn, emerged from the
term export marketing. A company that fails to go global is in danger of
losing its domestic business to competitors with lower costs, greater
experience, better products and in a nutshell more value for the customer.
1.9 SELF ASSESSMENT QUESTIONS
1. What do you mean by International Business?
2. Explain the growing importance of International Business.
3. Write a note on World Bank and its objectives.
4. Explain the factors responsible for the growth of International Business.
5. Explain the concept of International Finance with its significance to the
economy. 
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REFERENCE MATERIAL
Click on the links below to view additional reference material for this
chapter
Summary
PPT
MCQ
Video Lecture - Part 1
Video Lecture - Part 3 
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FUNDAMENTALS OF INTERNATIONAL FINANCE
Chapter 2
FUNDAMENTALS OF INTERNATIONAL
FINANCE
Learning Objectives
• What do you mean by International Finance
• Scope of International Finance
• Factors affecting Foreign Exchange Rates
• Balance of Payment and its Components
• Elements of Foreign Exchange Transaction
Structure:
2.1 Meaning of International Finance
2.2 Scope of International Finance
2.3 Factors Influencing Foreign Exchange Rates
2.4 Balance of Payment
2.5 Features of Balance of Payment
2.6 Components of Balance of Payment
2.7 Methods to Identify Surplus or Deficit in BOP
2.8 Elements of Foreign Exchange Transaction
2.9 Devaluation/Depreciation of Exchange Rate
2.10 Summary
2.11 Self Assessment Questions
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2.1 MEANING OF INTERNATIONAL FINANCE
• The study of International Finance essentially involves the study of
different mechanisms by which money can be raised in international
market.
• The main areas through which monetary resources are raised are:
a. International equity market
b. International debt market
c. International loan syndication
d. International trade credit
• All these mechanisms in different proportions involve two additional
variables beyond those applicable to raising resources domestically.
These additional variables are:
1. The rate of conversion between currencies is called the exchange
rate.
2. The rates of interest applicable to the two currencies being
exchanged.
• Thus, the study of International Finance, therefore, involves an
understanding of international economics and the mechanisms of foreign
exchange arithmetic.
2.2 SCOPE OF INTERNATIONAL FINANCE
• International Trade: International trade helps to achieve the following:
1. Transfer of efficiency from one geographical area to another.
2. Improvement in the standard of living of both communities.
3. Provides for better utilization of resources at a universal level.
• Foreign Exchange Market: The transactions which get executed
through the intermediation of banks where one currency gets converted
into another. This process is called 'Foreign Exchange’.
• International Financial Economics: It is concerned with causes and
effects of financial flows among nations.
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• International Financial Management: It is concerned with how
individual economic units, especially MNCs, cope with complex financial
environment of international business.
• International Financial Markets: It is concerned with international
financial/investment instruments, foreign exchange markets,
international banking, international security markets, financial
derivatives, etc.
2.3 FACTORS AFFECTING FOREIGN EXCHANGE RATES
Foreign Exchange rates are influenced by several factors in the
international market.These can be summarized as follows:
Gross Domestic Product (GDP)
GDP is the broadest measure of aggregate economic activity in a country
and represents the total value of final goods and services produced in a
country. GDP is the primary indicator of the strength of economic activity.
So, the growth in the GDP positively influences the foreign exchange price
of the currency. A fast growing economy will reflect strength in the
exchange rate and vice versa.
Trade Balance
This represents the difference between imports and exports of tangible
goods. The changes in exports and imports are recorded in the current
account of the BOP and therefore, have a ready immediate effect on the
demand-supply equation. This data is, thus, widely followed by the foreign
exchange market.
Inflation
Inflation is the rate of change in the price level of a fixed basket of goods
and services in an economy. In most countries the most widely followed
measure of inflation is the Consumer Price Index (CPI) i.e., the rate of
change in the price level of a fixed basket of goods and services purchased
by consumers. Inflation reduces the purchasing power of the currency.
! !22

Employment Levels
Employment levels in an economy reflect the development and stability in
the economy. An expanding economy would result in greater investments
which would result in more employment generation. This increases income
within the economy resulting in higher consumption and savings.
Exchange Rate Policy
In many countries, the exchange rate policy is decided by the Finance
Ministry. However, the execution of the exchange rate policy is always
managed by the Central Bank.The central bank of the country participates
in the local foreign exchange market by way of intervention to stabilize the
exchange rate or maintain it in a particular range.
Political Factors
Some of the common political developments such as elections, public
announcements by central bank or government officials, military takeovers,
political instability, etc. All such factors affect the exchange rate.
View of Speculators
More than 90% of the turnover in international foreign exchange markets
represents speculative activity. The view or perception of the likely value of
the currency of these participants in the market has a critical effect on the
exchange rate.
2.4 BALANCE OF PAYMENTS (BOP)
• International trade plays a major role in the economic development of a
country. The world is becoming an integrated market place and trade
equations are changing rapidly. Realizing the importance of private
capital inflow-outflow for the development of a country, many countries
are taking numerous measures to attract foreign investors.
• Balance of Payment is a term included in international trade.
! !23

IMF definition
Balance of payments is a statistical statement that summarises
transactions between residents and non-residents during a period.
"The balance of payments of a country is a systematic record of all
economic transactions between the residents of a country and the rest of
the world. It presents a classified record of all receipts on account of goods
exported, services rendered and capital received by residents and
payments made by them on account of goods imported and services
received from the capital transferred to non-residents or foreigners”.
— Reserve Bank of India
The above definition can be summed up as following:- Balance of Payments
is the summary of all the transactions between the residents of one
country and rest of the world for a given period of time, usually one year.
The definition given by RBI needs to be clarified further for the following
points:
A. Economic Transactions
An economic transaction is an exchange of value, typically an act in which
there is transfer of title to an economic good, the rendering of an economic
service or the transfer of title to assets from one economic agent
(individual, business, government, etc) to another. An international
economic transaction evidently involves such transfer of title or rendering
of service from residents of one country to another. Such a transfer may be
a requited transfer (the transferee gives something of an economic value to
the transferor in return) or an unrequited transfer (a unilateral gift). The
following are the basic types of economic transactions that can be easily
identified:
1. Purchase or sale of goods or services with a financial quid pro quo —
cash or a promise to pay. [One real and one financial transfer].
2. Purchase or sale of goods or services in return for goods or services
or a barter transaction. (Two real transfers)
! !24

3. An exchange of financial items, e.g., purchase of foreign securities
with payment in cash or by a cheque drawn on a foreign deposit.
[Two financial transfers]
4. A unilateral gift in kind [One real transfer].
5. A unilateral financial gift. [One financial transfer]
B. Resident
The term resident is not identical with "citizen" though normally there is a
substantial overlap. As regards individuals, residents are those individuals
whose general centre of interest can be said to rest in the given economy.
They consume goods and services; participate in economic activity within
the territory of the country on other than temporary basis.
• This definition may turn out to be ambiguous in some cases. The
"Balance of Payments Manual" published by the "International Monetary
Fund" provides a set of rules to resolve such ambiguities. As regards
non-individuals, a set of conventions have been evolved, e.g.,
government and non-profit bodies serving resident individuals are
residents of respective countries, for enterprises, the rules are somewhat
complex, particularly to those concerning unincorporated branches of
foreign multinationals.
• According to IMF rules these are considered to be residents of countries
in which they operate, although they are not a separate legal entity from
the parent located abroad. International organizations like the UN, the
World Bank, and the IMF are not considered to be residents of any
national economy although their offices are located within the territories
of any number of countries.
• To certain economists, the term BOP seems to be somewhat obscure.
Yeager, for example, draws attention to the word "payments" in the term
BOP; this gives a false impression that the set of BOP accounts records
items that involve only payments. The truth is that the BOP statements
records both payments and receipts by a country. It is, as Yeager says,
more appropriate to regard the BOP as a “balance of international
transactions" by a country.
! !25

• Similarly, the word "Balance" in the term BOP does not imply that a
situation of comfortable equilibrium; it means that it is a balance sheet of
receipts and payments having an accounting balance. Like other
accounts, the BOP records each transaction as either a plus or a minus.
• The general rule in BOP accounting is the following:-
(a)If a transaction earns foreign currency for the nation, it is a credit
and is recorded as a plus item.
(b)If a transaction involves spending of foreign currency it is a debit and
is recorded as a negative item.
• The BOP is a double entry accounting statement based on rules of debit
and credit similar to those of business accounting and book-keeping,
since it records both transactions and the money flows associated with
those transactions.
• Also, in case of statistical discrepancy the difference amount is adjusted
with errors and omissions account and thus, in accounting sense the BOP
statement always balances.
2.5 FEATURES OF BALANCE OF PAYMENTS (BOP)
Systematic Record
It is a systematic record of receipts and payments of a country with other
countries.
Fixed Period of Time
It is a statement of a account pertaining to a given period of time, usually
a year.
Comprehensiveness
It includes all the three items, i.e., visible, invisible and capital transfers.
The balance of payments is a comprehensive record of economic
transactions of the residents of a country with the rest of the World during
a given period of time. The aim is to present an account of all receipts and
! !26

payments on account of goods exported, services rendered and capital by
resident of a country and goods imported, services received and capital
transferred by residents of the country.
Double Entry System
Receipts and payments are recorded on the basis of double entry system.
The basic convention applied in constructing a balance of payments
statement is that every recorded transaction is represented by two entries
with equal values. One of these entries is designateda credit with a positive
arithmetic sign; the other is designated a debit with a negative sign. In
principle, the sum of all credit entries is identical to the sum of all debit
entries and the net balance of all entries in the statement is zero.
Self-balanced
From the point of view of accounting, double entry system automatically
keeps debit and credit sides of the accounts in balance.
Adjustment of Differences
Whenever there are differences in actual total receipts and payments, need
is felt for necessary adjustment.
All Items — Government and Non-government
Balance of Payments includes receipts and payments of all items
government and non-government.
2.6.COMPONENTS OF THE BALANCE OF PAYMENTS
ACCOUNT (BOP)
As it is evident, balance of payment is a collection of accounts of all such
eligible transaction that have bearing on the Forex position of the economy.
This BOP, the collection of accounts is conventionally grouped into three
main accounts with subdivisions in each. 
! !27

The major components in the BOP are:
A. Current Account
B. Capital Account
C. Reserve Account
D. Errors and Omissions Account
!
(A) Current Account
a. The current account of the BOP is made up of three balances namely
- Merchandise (Visible) balance, Services (Invisible) balance and
Unilateral Transfer Balance.
! !28

b. Effectively, it reflects the net flow of goods, services and unilateral
transfers (gifts,donations, legacies, etc.).
c. Balance on current account can be defined as the net value of the
balances of the visible trade, invisible trade and unilateral transfer
d. BOP on current account covers all receipts and payments arising out
of trade and personal remittances. It thus, has a direct impact on the
exchange rate of the domestic currency.
e. Following items are mainly included under current account:
1. Export and Import of Visible goods  
 
Import and Export of visible material goods and precious metals. In
other words, all goods included in balance of trade are the main items of
current account.
2. Invisible Items — Services 
 
Import and Export of invisible goods, i.e., different kinds of services
included in current account. Main Invisible services are:-
(i) Services Rendered by Commercial Undertakings: Commercial
undertakings like shipping companies, insurance companies, banks,
etc., belonging to a given country or different countries, exchange
their services among different countries. Exchanges of such services
are included in current account.
(ii)Services of Experts: Every country avails mostly the services of the
foreign experts like doctors, engineers, soldiers, etc. and also puts
the services of its experts at the disposal of the other countries. The
services received from abroad are imports and the services rendered
to foreign countries are exports.
3. Travelling 
 
One of the main invisible items of the balance of payments is travels.
These travelling may be of any account for instance, these may be in
connection with business, education, health, conventions or pleasure
! !29

trip, etc., the country visited to, for it these travels constitute exports
and use of foreign transport by the natives amounts to imports.
4. Transportation 
 
Movement of goods from one country to the other. Use of domestic
transport by the foreigners amounts to exports and use of foreign
transport by the natives amounts imports.
5. Investment Income 
 
Interest, rent, dividend and profit also form an invisible item of balance
of payments.  
 
When a country gets income from its investment abroad it is recorded
under the head 'Receipts'. 
 
On the other hand, when foreign investors earn income from the
country where they make investment, then it is recorded under the
head ‘Payments'.
6. Governmental Transactions 
 
Each government establishes its embassies, offices of high
commissioners and other missions abroad and spends a lot on their
maintenance. Such a expenditure is treated as payments. Besides
subscriptions, etc., made to international institutions are also included in
this category.
7. Donations and gifts 
 
Donations are gifts, etc., received from abroad are included under
'Receipts' and donations and gifts, etc., given to other countries are
included under ‘Payments'.
8. Miscellaneous  
 
These include such invisible items as commission, advertisement, rent,
patent fees, royalties, membership fees, etc., the amount received from
! !30

abroad on this count constitutes credit item and amount paid to other
countries in this respect constitutes debit item.
(B) Capital Account
a. The capital account records all international transactions that involve
creation of assets and liabilities in foreign currencies.
b. The capital account, thus, records all 'receivables and payables' which
would impact the demand-supply equilibrium in the future.
c. The classification of a transaction is either current or capital
therefore, does not depend on the nature of asset but on the nature
of the transaction.
d. The main items of capital account are as follows:
1. Private Foreign Loan Flow  
 
Foreign loans received by the private sector are counted as credit item
and repayments of these loans is counted as debit item.
2. Movement in Banking Capital 
 
Beside central bank, inflow of banking capital is counted as credit item
and outflow as debit item.
3. Official Capital Transactions 
 
Loans received by the public sector from abroad or International
Monetary Fund constitutes credit items and loans repaid debit items.
(C) Reserve Account
a. Reserve account forms a special feature of the capital account. This
account records the changes in the part of the reserves of other
countries that is held in the country concerned.
b. These reserves are held in three forms: in foreign currency, as gold
and as Special Deposit Receipts (SDRs).
! !31

c. The change in the reserves account measures a nation's surplus or
deficit on its current and capital account transactions by netting
reserve liabilities from reserve assets.
d. The main items of Reserve accounts are as follows:
1. Reserves, Monetary Gold and SDRs 
 
Foreign currency assets of the government, gold reserves of the central
bank, SDRs of IMF and similar capital transactions, etc., are included
under credit items and all kinds of payments under debit items
2. Gold Movements 
 
When the central bank of a country buys gold from abroad, it makes
payment to foreign sellers. It is reflected under debit items. On the
contrary, when it sells gold it is reflected under credit items.
3. Miscellaneous 
 
Beside the above items, all other kinds of governmental capital receipts
which also include receipts of the central bank are shown on credit side
and all kinds of payments are shown on debit side.
(D) Errors and Omissions Account
a. Errors and omissions account is a "statistical residue." It is used to
balance the statement because in practice it is not possible to have
complete and accurate data for reported items and because these
cannot, therefore, ordinarily have equal entries for debits and credits.
b. The entry for net errors and omissions often reflects unreported flows
of private capital, although the conclusions that can be drawn from
them vary a great deal from country to country, and even in the
same country from time to time, depending on the reliability of the
reported information.
c. The changes in the country's reserves must reflect the net value of all
the other recorded items in the balance of payments. These changes
are to be recorded accurately, and it is the discrepancy between
! !32

these changes in reserves and the net value of the other recorded
items that allows us to identify the errors and omissions.
d. For e.g., A remittance by an Indian working abroad to India may not
yet be recorded or a payment of dividend abroad by an MNC
operating in India may not yet be recorded or so on. The errors and
omissions amount equals to the amount necessary to balance both
the sides.
Balance of Payments Account
Receipts (Credits) Payments (Debits)
1. Export of goods Imports of goods
2. Export of services. Import of services.
3. Interest, profit and dividends received. Interest, profit and dividends paid.
4. Unilateral receipts. Unilateral payments.
Current Account Balance (1 to 4)
5. Foreign investments. Investments abroad.
6. Short-term borrowings. Short-term lending.
7. Medium and long-term borrowings. Medium and long-term lending.
Capital Account Balance (5 to 7)
8. Errors and omissions. (+) Errors and omissions.
9. Change in reserves. Change in reserves (-)
Total Receipts = Total Payments
! !33

2.7 METHODS TO FIND OUT SURPLUS OR DEFICIT IN BOP
ACCOUNT
1. Autonomous and Accommodating Capital Flows Concept
2. The Official Settlement Concept
I. Another approach for indicating, a deficit or surplus in the BOP is to
consider whether the net monetary transfer that has been made by
the monetary authority is positive or negative.
II. This means that the transfer to or from the Reserves Account
represents the extent of accommodation being provided by the
monetary authority for balancing surplus/ deficit in the autonomous
transactions.
III.Effectively, the monetary authority settles the disequilibrium in the
BOP and hence,such actions are called 'Official Settlements'.
No. Autonomous Tansactions Accommodating Transactions
1 These transactions are undertaken in
the normal course of business without
considering the equilibrium and no
specific intention of balancing BOP.
These transactions are
undertaken considering the
equilibrium and intention of
balancing the the BOP.
2 These transactions effectively represent
Current and Capital account
transactions.
These transactions effectively
represent Reserve account
transactions.
3 Classified as 'Above the Line’
transactions.
Classified as 'Below the Line’
transactions.
4 These transactions are normally
undertaken by market participants
other than the Central Bank.
These transactions are
undertaken by the Central
Bank.
5 BOP are surplus if net balance of
autonomous transactions are positive
BOP are deficit if net balance of
autonomous transactions are negative.
A surplus BOP result in an
increase in reserves whereas, a
deficit BOP result in a decrease
in reserves account.
! !34

3. Current Account Monetary Model
I. This model is based on the Purchasing Power Parity theory and on the
assumption that flexible exchange rates keep the balance of
payments in continuous equilibrium.
II. Consequently, it is implied that there are no changes in foreign
exchange reserves.
III.Nominal domestic money supply is determined by domestic credit
creation which is controlled by domestic monetary authorities.
IV. The monetary authority is not bound by any compulsion to intervene
in markets for protecting the exchange rate.
4. Capital Account Monetary Model
I. This Model was developed by economist Frankel in 1979. The Frankel
model suggests (like the current account monetary model) that an
increase in domestic money supply will, in the long run depreciate
the domestic currency, while an increase in demand for the domestic
currency will lead to of foreign currency appreciation.
II. The interest rate of a currency also has an impact on the appreciation
or depreciation of the domestic currency.
III.If interest rates increase due to tight monetary conditions, i.e.,
greater demand for the domestic currency, then the currency would
appreciate whereas, if the interest rate increase as a consequence of
higher inflation then the currency would depreciate.
2.8 ELEMENTS OF A FOREIGN EXCHANGE TRANSACTION
FIAT Currencies
FIAT currencies are paper currency notes issued by the Central Monetary
Authority of the respective countries, incorporating promise to redeem
these notes at face value. The intrinsic value of these notes is always less
than the face value.
! !35

Foreign Currency
The Foreign Exchange Management Act, 1999, defines:
"Foreign Exchange means foreign currency and includes-
(i) Deposits, credits and balances payable in any foreign currency.
(ii)Drafts, travellers cheques, letter of credit or bills of exchange,
expressed or drawn in Indian currency but payable in any foreign
currency; and
(iii)Drafts, traveller's cheques, letter of credit or bills of exchange drawn by
banks, institutions or persons outside India, but payable in Indian
currency".
NOSTRO accounts
Demand deposit accounts, denominated in foreign currencies maintained
by domestic banks with banks overseas are called NOSTRO accounts.
Nostro means 'our account with you'. Ex: If State Bank of India, Mumbai
has a US Dollar account with American Express Bank, New York then such
an account would be called a NOSTRO account.
VOSTRO accounts
Demand deposit accounts denominated in domestic currency maintained by
overseas banks with domestic banks are called VOSTRO accounts. Vostro
account means ‘your account with us'. Ex: If Standard Chartered Bank,
London has an INR account with Syndicate Bank, New Delhi then such an
account would be called a VOSTRO account.
LORO accounts
The term LORO is used when the NOSTRO/VOSTRO account is referred to,
by a bank other than the account maintaining bank and the bank with
which the account is maintained. In other words, it is used when referring
to third party accounts. Ex: If Canara Bank, Mumbai has an account with
Citibank, New York denominated in US Dollars then when Bank Of Baroda
! !36

has to refer to this account while corresponding with Citibank, it would
refer to it as LORO Account, meaning 'their account with you’.
Correspondent Banks
The bank with whom a nostro or vostro a/c relationship is established is
called correspondent bank. This bank essentially acts as an agent of the
domestic bank (principal) and undertakes various functions as follows:
1. Maintaining the foreign currency a/c
2. Providing temporary overdrafts as and when necessary.
3. Providing credit reports on companies located in the country of the
correspondent bank.
4. Assisting the principal bank in all agency functions.
5. Providing trade-related data and product data to help the principal bank.
Foreign Exchange
It can be defined as a transaction or mechanism which facilitates the
exchange between one legal tender and another. It involves transfers
through demand deposit accounts at both ends of an international
transaction. The actual conversion takes place through the use of Nostro/
Vostro accounts between international banks.
Foreign Exchange Market
The foreign exchange market can be defined as an electronically connected
network of international banks, brokers and service providers. The main
characteristics of this market are:
(a) This market does not involve any physical transfer of currencies.
(b) This market does not have any physical structure.
(c) This market helps to establish the rate of conversion between
currencies.
Other Elements
Favourable Balance of Payments — Value of total receipts more than total
payments.
! !37

Adverse Balance of Payments — Value of total receipts less than total
payments.
Balanced Balance of Payments — Value of total receipts equals total
payments.
Unrequited Receipts — Receipts for which nothing has to be paid in return.
Unrequited Payments — Payments for which nothing is received in return.
2.9 DEVALUATION / DEPRECIATION OF EXCHANGE RATE
1. Economies which operate on either a fixed exchange rate system or a
managed float system use the exchange rate to achieve equilibrium in
international trade.
 
NO. DEVALUATION DEPRECIATION
1 Represents reduction in the value of
the currency through official action.
Represents reduction in the value of
the currency through market
action.
2 It is one time action. It is a continuous process.
3 It cannot be predicted. It can be anticipated.
4 Associated with the fixed exchange
rate system.
Associated with the flexible
exchange rate system.
5
!
!
! !38

2.10 SUMMARY
BOP is a standard double entry accounting record to all the transactions of
an economy with Rest of the World (ROW). It is a regular double entry
accounting statement of economic transactions between the residents of a
country and the non-residents. For our reference, it may be enough to
interpret 'non-residents' as 'residents of foreign countries'.The term
'economic transactions' denotes any transaction wherein, something of
economic value is provided by one party to another. Balance of Payments is
a record of payments and receipts of the country. Hence, in strict sense, it
is a calculation of Balance of Payments and Receipts.
1. Balance of Payments as representative of demand and supply factors for
foreign currencies.
2. Factors affecting demand for and supply of foreign currencies.
3. Factors influencing exchange rates.
4. Benefits of BOP Analysis.
5. Nostro/Vostro/Loro. 
! !39

REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !40

INTERNATIONAL FOREIGN EXCHANGE MARKETS
Chapter 3
INTERNATIONAL FOREIGN EXCHANGE
MARKETS
Learning Objectives
• Foreign Exchange Control
• Foreign Exchange Control in India
• International Foreign Exchange Market in India
• Dealing Room Operations
• MIBOR
Structure:
3.1 Introduction of Foreign Exchange Control
3.2 The Origin or Evolution of Exchange Control
3.3 Meaning of Exchange Control
3.4 Characteristics of Exchange Control
3.5 Merits of Exchange Control
3.6 Demerits of Exchange Control
3.7 Origin of Exchange Control in India
3.8 Objectives of Exchange Control in India
3.9 Features of Exchange Control in India
3.10 Foreign Exchange Market Introduction
3.11 Participants in Foreign Exchange Market
3.12 Features of International Foreign Exchange Market
3.13 Dealing Room Operations
3.14 Distinction between Merchant and Interbank Transactions
3.15 Mumbai Inter-Bank Offer Rate (MIBOR)
3.16 Summary
3.17 Self-assessment Questions
! !41

3.1 INTRODUCTION OF FOREIGN EXCHANGE CONTROL
• Foreign Exchange Control refers to the control of international monetary
and economic transactions involving foreign exchange either by
government directly or a centralized agency like central bank.
• There are various forms of controls imposed by a government on the
purchase/sale of foreign currencies by residents or on the purchase/sale
of local currency by non-residents. Common foreign exchange controls
include:
➡ Banning the use of foreign currency within the country
➡ Banning locals from possessing foreign currency
➡ Restricting currency exchange to government-approved exchangers
➡ Fixed exchange rates
➡ Restrictions on the amount of currency that may be imported or
exported
• Countries with foreign exchange controls are also known as "Article 14
countries,"after the provision in the International Monetary Fund
agreement allowing exchange controls for transitional economies.
• Such controls used to be common in most countries, particularly poorer
ones, until the 1990s, when free trade and globalization started a trend
towards economic liberalization. Today, countries which still impose
exchange controls are the exception rather than the rule.
• In this exchange control, free play of market forces is restricted by
certain regulative measures in the exchange market. The rate of
exchange under this system will naturally be different from one that will
exist in the absence of such control.
• In today's world economy, almost all the countries in the world have
adopted some form of exchange control or other. In some, it exists in its
extreme form with all its complexities. The control extends over all
transactions of international receipts and payments which are centralized
and all payments are rationed.
! !42

• The countries proclaiming to abolish the exchange control also have
some forms of control. Thus, it is difficult in present times to conceive an
economy which is absolutely free from all sorts of exchange control.
• Regulation at government level of money-flows in and out of a country.
Exchange controls are usually maintained in the belief that they help to
protect a country’s currency and its foreign-exchange reserves.
• The controls may restrict investments by residents overseas and non-
residents’ investments and participation in the local market. Big
international currency movements tend not to obey such controls.
• Sometimes individuals are limited in the amount of currency they may
take abroad for holidays. The UK abandoned exchange controls in 1979.
In Australia, exchange controls which had persisted in one form or
another since 1939, were virtually abolished in December 1983, when
the AUD was floated.
• Types of controls that governments put in place to ban or restrict the
amount of foreign currency or local currency that is allowed to be traded
or purchased. Common exchange controls include banning the use of
foreign currency and restricting the amount of domestic currency that
can be exchanged within the country.
• Typically, countries that employ exchange controls are those with weaker
economies.These controls allow countries a greater degree of economic
stability by limiting the amount of exchange rate volatility due to
currency inflows/outflows.
• The International Monetary Fund has a provision called Article 14, which
only allows countries with transitional economies to employ foreign
exchange controls.
3.2 THE ORIGIN OR EVOLUTION OF EXCHANGE CONTROL
• The origin of the foreign exchange control can be traced back to thirties.
After World War I, the Germany adopted exchange control to stabilize its
continuously depreciating Mark.
! !43

• After it in the same contemporary period, almost all the European
countries resorted to this technique and after World War II almost all the
countries of the world have adopted this technique of exchange control.
• There is hardly any country today which has not adopted in one form or
the other, the system of exchange control.
3.3 MEANING OF EXCHANGE CONTROL
• The foreign exchange control is a system in which a country introduces
some regulatory measures to curb the free play of market forces in the
foreign exchange market.
• The government imposes control on the purchase and sale of foreign
currencies in that system. The term exchange control is used in two
different senses, in the wide sense as well as the narrow sense.
• In the wide sense, the term exchange control refers to all those
intervening activities of government which are intended to influence the
rate of exchange or the business connected with the foreign exchange
and also includes such things as the imposition of control on exchange
rate, exchange equalization accounts as well as the conclusion of trade
and payment agreements with other countries.
• In narrow sense, the exchange control refers to these restrictions which
are imposed by the government on foreign exchange business.
3.4 CHARACTERISTICS OF EXCHANGE CONTROL
1. All types of international transactions involving foreign exchange are
centralized.
2. State has full control over the foreign exchange business in the market.
3. Only those possessing licences can deal in foreign exchange.
4. The government fixes the priorities for distribution of foreign exchange.
5. The whole foreign exchange is deposited with central bank which gives
the exporters domestic currency in return.
! !44

6. The importers get foreign currency from the central bank.
7. Rate of exchange is determined officially by the government and it is
also managed.
3.5 MERITS OF EXCHANGE CONTROL
• It maintains exchange rate stability.
• It is aimed to keep exchange rate in the economy different from the
market exchange rate.
(i) Under Valuation: This policy is adopted for curing the depression.
Under this system, the country fixes rate lower than it would be in a
free exchange market. It will give stimulus to export and domestic
industries and import will be discouraged. As the result, balance of
trade and payments turn in favour of the country.
(ii) Over Valuation: In this objective, a country fixes the value of its
currency at a level higher than it would be if there was no
intervention in foreign exchange. It is adopted when the country is
suffering from inflation and to meet the large debt payments
expressed in foreign currency and the country is in need of foreign
goods.
• It intends to iron out temporary ups and downs and this is done through
exchange equalization account.
• It also aims to correct persistently adverse balance of payments.
• It helps in conserving country's depleting gold reserves and foreign
exchange reserves.
• With exchange control, country also regulates capital movement in order
to prevent the flight of capital from the country.
• Country with exchange control aims objective for its economic growth
with stability.
! !45

• Exchange control done with a view to encourage trade with a particular
country or group of countries (trade block), this is called bilateralism.
• Exchange control provides protection against the tough foreign
competition.
• Exchange control helps in proper execution of the economic plans and
developmental planning in the country.
• It removes the imbalance and deficit in the international trade by
restricting foreign exchange to the importers for importing goods.
• The Government may prohibit the import of certain commodities
altogether with the help of exchange control.
• It could be utilized to earn profit by keeping a wide margin between
buying and selling rates of foreign exchange.
• Through exchange control, a country can adjust the domestic demand of
export and import. By this adjustment a country can maintain internal
price stability.
• Through exchange control, a country tries to escape from the abuses of
international economic crises.
• Exchange control facilitates in making orderly and timely international
debts and other payments.
• Exchange control also maintains the fixed and stable relations with
important currencies to which they have more transactions.
3.6 DEMERITS OF EXCHANGE CONTROL
• As all control gives birth to the dichotomy in the economy and encourage
political and administrative corruption in the country.
• Under exchange control, a country puts an end to the working of a
principle of comparative cost. In this, a country also produces those
commodities in which it does not enjoy advantages.
! !46

• A country has to employ an army of competent officials which is not
feasible for underdeveloped countries.
• It generates the feeling of fulfilling national interest at all costs and this
ultimately creates tension among international community.
• Due to exchange control, there are more fluctuations in the international
economy which encourages the working of business cycles.
• It is against the consumer's interest.
• It obstructs economic cooperation internationally.
• It discourages multilateral trade.
• In the long run, exchange control results in the creation of fundamental
disequilibrium which is more harmful for the economy.
• The criteria laid down for the various types of control are arbitrary in
nature.
• Exchange control puts several restrictive measures in the way of free
trade; it will reduce the volume of international trade
• It also presents several hurdles and obstacles in establishing
specialization in production of several commodities because of imposing
of several restrictions on free trade.
• Exchange control is also not conducive for free flow of capital movement
and investment and that is not in the interest of the economy.
3.7 ORIGIN OF EXCHANGE CONTROL IN INDIA
• In India, exchange controls were first introduced on September 3, 1939,
by government of India. Immediately, after the outbreak of Second World
War No exchange controls were administered before this introduction,
though during first war there were fluctuations in the exchange rate of
Indian Rupee in terms of Sterling and it encouraged speculative activities
and produced adverse repercussions on the country's trade.
! !47

• With the introduction of exchange control in 1939, the government
empowered the Reserve Bank of India under the Defence of India Rules
(DIR), to administer the exchange control of India.
• The RBI, then set up a separate 'Exchange Control Department' for the
proper administration of the exchange control. In 1939 itself, RBI
enunciated its exchange control policy for the benefits of exporters and
importers and to conserve the non Sterling area currencies to utilize
them for essential purposes.
• Due to these developments, it became clear that foreign exchange
control would have to continue in some form or the other in the post war
period, also in the interest of making the most prudent use of the foreign
exchange resources.
• It was felt necessary to continue the exchange control on a systematic
and longterm basis. It was, therefore, decided to place the exchange
control on a statuary basis and the FOREIGN EXCHANGE REGULATION
ACT of 1947, was enacted.
• This Act since been replaced by the Act of 1973 and then after
liberalization of the economy with many modifications with a new name.
It was further replaced by Foreign Exchange Management Act, 1999,
(FEMA).
• Over the years, the scope of exchange control has been substantially
widened and the regulations have become more progressive in view of
the increasing demand of foreign exchange for the planned development.
• It became an integral part of the planned process of development. Its
scope was so further extended to Sterling area and after 1951, Pakistan
and Afghanistan also came into its fold.
• Exchange control in India is administered by the RBI. It is related to and
supplemented by trade control and the responsibility of which has been
entrusted to chief controller of imports and exports now re- designated
as Director General Foreign Trade (DGFT), under the ministry of
commerce.
! !48

• For trade control in our country, we enact the Imports and Exports
Control Act 1947, which has been replaced by the Foreign Trade
Development & Regulation Act (FTDRA), 1992.
• Under the exchange control, the RBI had empowered selected
commercial banks to deal in foreign exchange. In other words, the sale
and purchase was to be conducted by these banks only.
• A major portion of foreign exchange dealings is dealt with these banks in
India which have been authorized by RBI to deal in foreign exchange as
‘Authorized Dealers' in foreign exchange.
3.8 OBJECTIVES OF EXCHANGE CONTROL IN INDIA
(i) Protection of Balance of Payments
One of the important objectives of exchange control is protection of
balance of payments. When the balance of payments deficit of a nation
becomes large and chronic and its automatic correction is not possible,
certain active measures have to be adopted. In normal times, the adverse
balance of payments caused value of country's currency to fall and helps in
restoring equilibrium.
(ii) Reducing Burden of Foreign Debt
The exchange value of a currency is sometimes fixed and maintained at
higher level to lighten the burden of foreign debts contracted in terms of
foreign currencies. By overvaluing currency, the foreign exchange earnings
of the country from exports are increased in cases where the demand is
inelastic and the prices in terms of the home currency to be paid for
essential imports get reduced.
(iii)Raising the Level of Prices
Sometimes, the currency is undervalued to help in raising certain
conditions that are desirable to stabilize the exchange rate at what can be
called the equilibrium level, i.e., the level determined by market forces.
Short-term fluctuations are eliminated by deliberate action of authorities.
! !49

(iv)Elimination of Short-term Fluctuations in Exchange Rate
Exchange regulation in certain conditions is thought desirable to stabilize
the exchange rate at what can be called the equilibrium level, i.e., the level
determined by market forces.
(v) Prevention of Export of Capital
When the country suffers from exceptionally heavy outflow of capital
caused by loss of confidence on the part of nationals of the country or
foreigners in the economy of the country or its currency, certain exchange
controls over remittances from and to the country are necessary
(vi)Economic Planning
Exchange control is an important part of economic policy in any planned
economy. Planning involves a very careful use of foreign exchange
resources of the country, so that only those goods are imported which are
essential for the implementation of the plans. Exchange controls are
resorted to regular the exports and imports in the light of plans.
(vii)Encouragement of Certain Economic Activities
One of the objectives of exchange regulations is to encourage certain
economic activities in the country. Certain industries can be developed by
reducing the imports of commodities produced by them and restricting the
availability of foreign exchange to pay for them.
3.9 FEATURES OF EXCHANGE CONTROL IN INDIA
1. Authority of Control: The main authority in this field is entrusted to
Finance Ministry of Government of India and Reserve Bank of India. For
smooth implementation of the exchange control, RBI takes the help of
several authorized dealers and authorized money changers, etc.
2. Foreign Currency Receipts: Any person earning foreign exchange
from any source has to surrender it before authorized dealer. He can
keep upto $500 with him. A foreign tourist can bring foreign money
without any limit. Any person residing abroad can remit up to $5000 as
! !50

gift instead of previously $1000 to the relative or friend in India. NRIs
can remit money without any limit.
3. Foreign Currency Payments: In making foreign payment for various
purposes like imports of goods and services, education, tourism and
travel, transportation, insurance for all these payments liberal rules
have been framed in comparison to previous rules of FERA. A person
can remit the amount of $25000 without permits of RBI for foreign visit.
4. Administration: The FEMA has assigned more powers to RBI in the
administration of exchange control in the country. RBI has its own
foreign exchange control department under the direct control of the
governor of the bank. There are several other deputy controllers to look
after its sub-offices at Mumbai, Kolkata, New Delhi, Chennai and
Kanpur. The FEMA provides for appointment of director enforcement for
taking up investigations of the contraventions under this act
5. Exchange Rates: After delinking of Indian Rupee with pound sterling,
the exchange rate of Indian Rupee is fixed in accordance with a basket
of selected currencies. Now the value of rupee floats according to the
relative demand and supply of foreign exchange. In emergent
situations, the RBI has power to manage the fluctuations.
6. Convertibility of the Rupee: Free convertibility of a currency means
that the currency can be exchanged or converted for any other currency
without any restrictions at the market determined exchange rate.
Convertibility of the rupees thus means that the rupee can be freely
converted into dollar, pound, and euro, yen, etc. and vice versa at the
rates of exchange determined by the market forces of demand and
supply.
7. Enforcement of Money Laundering Prevention Act 2002: The
government of India enacted an Act in 2002, the Money Laundering
Prevention Act to prevent entry of unlawful money into the country.
8. Superiority of FEMA over FERA: FERA to FEMA marks a positive shift
from control to management of foreign exchange. There are several
grounds on which, we can conclude that the FEMA is superior in
comparison to FERA. Some of the grounds are —
! !51

a) Many provisions of FERA like the ones relating to blocked accounts,
Indians taking up employment abroad, employment of foreign
technicians in India, vexations search, etc., have no appearance in
FEMA.
b) There is lot of deregulation as FEMA only regulates foreign exchange
and FERA controls everything that has to do with foreign exchange.
c) FEMA is much smaller enactment having only 49 sections against 81
of FERA
d) FEMA has more liberal and transparent rules regarding foreign
investment in comparison to FERA.
e) Contravention under FEMA is liable only for penalty up to thrice the
amount involved, while it is was five times in FERA with provision of
imprisonment.
f) The contravention in the FERA is dealt as a criminal offence and
there are provisions of imprisonment also in addition to penalties
while in FEMA violations, it is dealt as civil matters and there is
provision of only penalty.
g) The liability of proving the crime is on the party in FERA but in FEMA
it lies on the enforcement agency
3.10 FOREIGN EXCHANGE MARKET INTRODUCTION
• In today's world no economy is self-sufficient, so there is need for
exchange of goods and services amongst the different countries. So in
this global village, unlike in the primitive age the exchange of goods and
services is no longer carried out on barter basis.
• Every sovereign country in the world has a currency that is legal tender
in its territory and this currency does not act as money outside its
boundaries. So whenever a country buys or sells goods and services from
or to another country, the residents of two countries have to exchange
currencies.
! !52

• So we can imagine that if all countries have the same currency then
there is no need for foreign exchange. Foreign exchange market is
described as an OTC (over the counter) market as there is no physical
place where the participants meet to execute the deals, as we see in the
case of stock exchange.
• The largest foreign exchange market is in London, followed by the New
York, Tokyo, Zurich and Frankfurt. The markets are situated throughout
the different time zone of the globe in such away that one market is
closing the other is beginning its operation.
• Therefore, it is stated that foreign exchange market is functioning
throughout 24 hours a day. In most market US dollar is the vehicle
currency, viz., the currency used to dominate international transaction.
In India, foreign exchange has been given a statutory definition.
• Section 2 (b) of Foreign Exchange Regulation Act, 1973, states: 
 
Foreign exchange means foreign currency and includes:
➡ All deposits, credits and balance payable in any foreign currency and
any draft, traveller's cheques, letter of credit and bills of exchange,
expressed or drawn in Indian currency but payable in any foreign
currency.
➡ Any instrument payable, at the option of the drawee or holder thereof
or any other party thereto, either in Indian currency or in foreign
currency or partly in one and partly in the other.
• In order to provide facilities to members of the the public and foreigners
visiting India, for exchange of foreign currency into Indian currency and
vice versa.
• RBI has granted to various firms and individuals, licence to undertake
moneychanging business at seas/airport and tourism place of tourist
interest in India.
• Besides certain authorized dealers in foreign exchange (banks) have also
been permitted to open exchange bureaus.
! !53

3.11 PARTICIPANTS IN FOREIGN EXCHANGE MARKET
The main players in foreign exchange market are as follows:
1. Customers: The customers who are engaged in foreign trade
participate in foreign exchange market by availing of the services of
banks. Exporters require converting the dollars into rupee and importers
require converting rupee into the dollars, as they have to pay in dollars
for the goods/services they have imported.
2. Commercial Bank: They are most active players in the Forex market.
Commercial bank dealing with international transaction offer services for
conversion of one currency into another. They have wide network of
branches. Typically banks buy foreign exchange from exporters and sells
foreign exchange to the importers of goods. As every time the foreign
exchange bought or oversold position. The balance amount is sold or
bought from the market.
3. Central Bank: In all countries, Central bank have been charged with
the responsibility of maintaining the external value of the domestic
currency. Generally, this is achieved by the intervention of the bank.
4. Exchange Brokers: Forex brokers play very important role in the
foreign exchange market. However, the extent to which services of
foreign brokers are utilized depends on the tradition and practice
prevailing at a particular Forex market centre. In India, as per FEDAI
guidelines the Authorised Dealersare free to deal directly among
themselves without going through brokers. The brokers are not among
to allowed to deal in their own account all over the world and also in
India.
5. Overseas Forex Market: Today the daily global turnover is estimated
to be more than US $ 1.5 trillion a day. The international trade,
however, constitutes hardly 5 to 7% of this total turnover. The rest of
trading in world Forex market is constituted of financial transactions and
speculations. As we know that the Forex market is 24-hour market, the
day begins with Tokyo and thereafter, Singapore opens, thereafter India,
followed by Bahrain, Frankfurt, Paris, London, New York, Sydney, and
back to Tokyo.
! !54

6. Speculators: The speculators are the major players in the Forex
market.
• Bank dealers, are the major speculators in the Forex market with a
view to make profit on account of favorable movements in exchange
rates. They take position, i.e., if they feel that rate of particular
currency is likely to go up in short-term. They buy that currency and
sell it as soon as they are able to make quick profit.
• Corporation's, particularly multinational and transnational corporations
having business operations beyond their national frontiers and on
account of their cash flows being large and in multi currencies get into
foreign exchange exposures. With a view to take advantage of
exchange rate movement in their favour, they either delay covering
exposures or do not cover until cash flow materialize.
• Individuals, like share dealers also undertake the activity of buying and
selling of foreign exchange for booking short-term profits. They also
buy foreign currency stocks, bonds and other assets without covering
the foreign exchange exposure risk. This also result in speculations
3.12 FEATURES OF INTERNATIONAL FOREIGN EXCHANGE
MARKET
(1) The primary objective of the foreign exchange market is to facilitate
international trade and investment, by allowing end-users to convert
one currency into another.
(2) The modern foreign exchange market started with the introduction of
the ‘Flexible Exchange Rate System' during the 1970s.
(3) The principle characteristics of this market are:
a) It is decentralized, over-the-counter (OTC) market, engaged in
negotiated transactions.
b) It enjoys the highest trading volume which results in high liquidity.
c) International foreign currency transactions do not involve transfers of
currencies in cash form
! !55

d) All transactions in this market get routed through the banking
system.
e) The actual settlement of transactions is done through a network of
‘NOSTRO' and 'VOSTRO' accounts maintained by banks worldwide.
f) It is geographically dispersed across all countries which makes it a
universal market. However, in each country there is a domestic
foreign exchange market governed by individual regulations.
g) It operates 24 hours a day, except weekends, across all times zones.
h) It operates on very fine (low) profit margins compared to other
markets.
i) The International Foreign Exchange Market provides for a "BARTER"
of currencies, i.e., there is exchange of one currency against another.
j) It has no physical existence and operates as an electronically
connected network of end-users, banks, brokers and service
providers.
k) The most modern communication systems are used thereby, reducing
transaction costs, eliminating interest loss factor and the problem of
idle funds.
3.13 DEALING ROOM OPERATIONS
The Dealing Room Operations are classified as follows:
A. Foreign Exchange Dealing Room Operations
1. It is a profit centre for the bank and functions as a centralized service
branch to meet the needs of all other branches to buy/sell foreign
currencies.
2. It is managed by specially trained personnel called 'dealers or
traders', who undertakes all foreign currency operations.
! !56

3. The primary function of the Dealing Room is to provide rates for
various transactions which get reported to the Dealing room.
4. Rates provided by a bank to its customers are called 'Merchant
Rates'. These rates can be explained as follows:-
(I) Card Rates
1. The card rates are the rates at which the dealer quotes the rates to
their customers, i.e., at the start of every trading day the market first
establishes the vehicle currency quotation.
2. The dealers then prepare cross rates for currencies normally used by
their customers.
3. Profit margins are loaded for different categories of transactions and
tabulated under eight heads: TT Buying, Bills Buying, TC Buying, CN
Buying, TT Selling, Bills Selling, TC Selling and CN Selling.
4. These rates are collectively called as Card Rates and all transactions
are undertaken at branches involving amounts less than $5000 or
equivalent during the day are put through at card rates.
(II)Ready Rates
When branches receives transactions involving amounts in excess of
USD 5000 or equivalent, a transaction specific rate is provided by the
Dealing Room and this rate is known as Ready Rates.
(III)Conclusion
Thus, card rates are standardized whereas, ready rates are
customized.
B. Dealing Room Transactions
All transactions in the Dealing Room are classified as follows:
(I) Merchant Transactions
! !57

1. Customers of the bank continuously approach the bank for rates, i.e.,
either card or ready rates are applied depending on the volume of
each transaction.
2. Every deal is reported to Dealing Room where it is recorded into
respective currency position.
(II)Inter Bank Transactions
Transactions that are undertaken either to 'cover' merchant
transactions to lock the profit margins or represent proprietary trading
or speculative transactions done in keeping with the view of the
dealers regarding anticipated rate movements. All such transactions
are conducted at interbank rates and are standardized in nature.
Interbank deals are classified in terms of their settlement maturity,
i.e.: Cash, Tom, Spot or Forward.
Conclusion
Thus, merchant transactions apply more focus on customer's of the banks
whereas,Interbank transactions deals with banks or institutions.
3.14 DISTINCTION BETWEEN MERCHANT AND INTER BANK
TRANSACTIONS
Merchant Transactions Interbank Transactions
Represent transactions between the
bank and its customers.
Represent transactions between the
bank and other banks or institutions.
Transactions are initiated by the
customers (end-users).
Transactions are initiated by the bank
to cover merchant deals or acquire
speculative positions.
Customized deals. Standardized deals.
Do not involve brokers. May or may not involve brokers.
! !58

3.15 MUMBAI INTER BANK OFFER RATE (MIBOR)
1. The Committee for the Development of the Debt Market had studied and
recommended the modalities for the development of a benchmark rate
for the ‘Call Money Market' in India.
2. Accordingly, the National Stock Exchange of India Limited had
developed and launched the NSE Mumbai Inter-Bank Bid Rate and NSE
Mumbai Inter-Bank Offer Rate (MIBOR) for the overnight money market
on June 15, 1998.
3. The Fixed Income Money Market and Derivatives Association of India
(FIMMDA) and NSEIL now provide co-branded reference rates renamed
as ‘FIMMDA-NSE MIBID/MIBOR’.
4. Rates are provided for 1 Day, 3 days (only on Fridays), 14 days, 1
month & 3 months maturity.
5. These rates represent the interest rates at which banks can borrow
funds, in market lots, from other banks in the Indian inter-bank market.
6. These rates are used as benchmark rates for Interest Rate Swaps,
Forward Rate Agreements, Floating Rate Debt instruments, Term
Deposits and calculation of swap points for foreign exchange forward
market.
Conducted at merchant rates which are
quoted to nearest 0.0025 paisa.
Transactions classified as per rate
types: TT, Bills, TC and CN.
Conducted at interbank rates which are
quoted to nearest 0.0005 paisa.
Transactions classified in terms of
settlement types: Cash, Tom, Spot and
Forward.
Represents the retail segment of the
market and are governed by Exchange
Control Regulations of RBI.
Represent, the wholesale segment of
the market and are subject to RBI
rules and guidelines of the Foreign
Exchange Dealers Association of India.
! !59

3.16 SUMMARY
The foreign exchange market is an over-the-counter market. This means
that there is no single physical or electronic marketplace or an organised
exchange (like a stock exchange) with a central trade clearing currency
mechanisms where traders meet and exchange currencies. The market
itself is actually a worldwide network of inter bank traders, consisting
primarily of banks, connected by telephone lines and computers. The
markets span all the time zones of the world and functions virtually round
the clock enabling a trader to offset a position created in one market by
using another market. Of course, of the dozen or so market centres, the
really major ones are London, New York and Tokyo. Other important
centres are Zurich, Frankfurt, Hong Kong and Singapore.
1. Describe in detail the characteristics of the International Foreign
Exchange Market
2. Describe the operations of a Foreign Exchange Dealing Room.
3. Explain the Foreign Exchange Market in India.
4. How did the origin or evolution of Exchange Control occur?
5. Who are dealers? What role do they play in Dealing Room operations? 
! !60

REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !61

FOREIGN EXCHANGE MANAGEMENT IN INDIA
Chapter 4
FOREIGN EXCHANGE MANAGEMENT IN
INDIA
Learning Objectives
• Foreign Exchange Management in India
• Retail v/s Wholesale Foreign Exchange Market
• Capital Account Convertibility
• Reserve Management
• Foreign Exchange Dealers Association of India (FEDAI)
Structure:
4.1 Introduction to Indian Foreign Exchange Market
4.2 Structure of Indian Foreign Exchange Market
4.3 Management of Foreign Exchange in India
4.4 The Components of the Indian Foreign Exchange Market
4.5 Retail v/s Wholesale Foreign Exchange Market
4.6 Capital Account Convertibility
4.7 Reserve Management
4.8 Role of FEDAI in the Foreign Exchange Market
4.9 The Liberalized Exchange Rate Management System (LERMS)
4.10 The Unified Exchange Rate Management System
4.11 Pros And Cons of Currency Convertibility
4.12 Summary
4.13 Self-assessment questions
! !62

4.1 INTRODUCTION TO INDIAN FOREIGN EXCHANGE
MARKET
1. The Foreign Exchange Management Act, 1999 (FEMA), provides the
Central Government the powers to execute the provisions of the Act,
and provides the RBI the powers to make regulations for executing the
provisions of the Act in terms of Sec. 46 and Sec. 47 of the Act
respectively.
2. Section 41 provides that the Central Government may direct or instruct
the RBI who shall comply with such directions or instructions.
3. The RBI therefore has the sole authority as well as the responsibility to
administer the foreign exchange business in the country.
!
! !63

4.2 STRUCTURE OF INDIAN FOREIGN EXCHANGE MARKET
The above structure of Indian Foreign exchange market can be explained
as follows:-
1. Authorized Person 
 
The Reserve Bank provides licences to three categories of persons called
Authorized Dealers, Money Changers and Offshore Banking Units (OBUs)
to transact with the public at different levels. All such transactions, with
end-users are governed by the Exchange Control Regulations provided
by the Reserve Bank of India.
2. Authorized Dealers 
 
The bulk of the foreign exchange transactions undertaken in the country
involve endusers and banks. Banks and select entities licensed by the
Reserve Bank to undertake these transactions are called 'Authorized
Dealers' (ADs). They are permitted to undertake all categories of
transaction pertaining to both the Current and Capital accounts of the
Balance of Payments.
3. Authorized Money Changers 
 
Authorized money changers are sub-classified as full-fledged money
changers and restricted money changers. Full-fledged money changers
are permitted to undertake both purchase and sale transactions with the
public, e.g., Travel agencies. Restricted money changers are permitted
only to purchase foreign currency notes and traveller's cheques, e.g., 5
star hotels.
4. Offshore Banking Units 
 
Branches of banks in India established in Special Economic Zones
(SEZs) are accorded the status of Offshore Banking Units (OBUs). The
OBUs are allowed to undertake banking operations only in designated
foreign currencies essentially with non-residents. Each such OBU has a
minimum start-up capital of USD 10 million and its balance sheet is
prepared in designated foreign currencies.
! !64

International finance 315_v1

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