1.Finance: Exchange rate:
Prior to the institution of International Monetary Fund, the international monetary system was following the fixed change rate system based on the international gold standard. Under the gold standard the value of the currency was kept equal to the value of a fixed weight of gold. Over the years the gold standard took three forms (a) gold currency standard, (b) gold bullion standard; and (c) gold exchange standard.
2. Exchange Rate System under IMF:
The International Monetary Fund was instituted with a avowed objective of facilitating smooth running of the international trade and betterment of all nations of the world. It was thought that a system of fixed exchange rates would be necessary for the smooth functioning of international finance. The original scheme of the International Monetary Fund therefore provided that:
a) Each member country should declare the external value of its currency in terms of gold and a currency pegged to gold. Most countries declared values of their currencies in terms of gold and US dollar. This was known as the par value of the currency.
b) The value of US dollar was fixed at USD 35 per ounce of fine gold. The USA committed itself to convert dollars into gold at the above official price.
c) Following the above, the monetary reserves of member countries came to consist of gold and US dollars. Thus US dollar got the position of a reserve asset.
d) Each country agreed to maintain the market value of its currency within a margin of 1% of the par value. Where the variation in the market is more than the permitted level, the country should take steps to devalue the currency to correct the position.
e) Members were free to devalue their currencies. But, if the devaluation exceeded 10% of the par value, approval of the International Monetary Fund should be obtained. The International Monetary Fund might approve it or advise a lower rate. However, it had no power to reject the proposal.
f) The International Monetary Fund granted short term financial assistance to its members to tide over their temporary balance of payments problems. For chronic problems the members were expected to use permanent solutions like devaluation.
3. Foreign trade and Foreign exchange:
International trade refers to trade between the residents of two different countries. Each country functions as a sovereign State with its own set of regulations and currency. The difference in the nationality of the exporter and the importer presents certain peculiar problems in the conduct of international trade and settlement of the transactions arising there from. Important among such problems are:
a) Different countries have different monetary units;
b) Restrictions imposed by countries on import and export of goods;
c) Restrictions imposed by nations on payment from and into their countries; and
d) Differences in legal practices in different countries.
The existence of national monetary units poses a problem in the settlement of International transactions.
The exporter would like to get the payment in the currency of his country. For instance, if American export machinery to Indian imports, the former would like to get the payment in US dollars. Payment in Indian rupees will not serve their purpose because Indian rupee cannot be used as currency in the United States. On the other hand, the importers in India have their savings and borrowings in India in rupees. Thus the exporter requires payment in the currency of the exporters country whereas the importer can pay only in the currency of the importers country. A need therefore arose for conversion of the currency of the importers country into that of the exporters country. Foreign exchange rates is the mechanism by which the currency of one country gets converted into the currency of another country.
The conversion of currencies is done by banks who deal in foreign exchange. These banks maintain stocks of foreign currencies in the form of balances with banks abroad. For instance, Indian Bank may maintain an account with Bank of America, New York, in which dollar balances are held.
4. Exchange rate:
The rate at which one currency is converted into another currency is the rate of exchange between the currencies concerned. If Indian Bank exchanged US dollars for Indian rupees at Rs.45 a dollar, the exchange rate between rupee and dollar can be expressed as USD 1 = Rs.45.
The rate of exchange for a currency is known from the quotation in the foreign exchange market. The banks operating at a financial center and dealing in foreign exchange, constitute the foreign exchange market. As in any commodity or stock market, the rates in the foreign exchange market are determined by the interaction of the forces of demand for and supply of the commodity dealt in, namely, foreign exchange. Since the demand and supply are affected by a number of factors, both fundamental and transitory, the rates keep on changing frequently and violently too.
5. Balance of payments:
Balance of payment is a record of the value of all transactions between residents of a country with outsiders. It constitutes the result of demand for and supply of foreign exchange for various purposes. Since the rate of exchange between currencies is determined by the forces of demand and supply, balance of payments is the fundamental factor in determining the exchange rates. A change in the balance of payments of a country will affect the exchange rate of its currency.
Definition: Balance of payments is the systematic summary of the economic transactions of the residents of a country with the rest of the world during a specified time period, normally a year. The following features of the balance of payments are implicit in the above definition:
1) Economic Transactions: The statement is a summary of economic transactions of the country with the outsiders. An economic transaction arises when values are exchanged or moved between nations.
2) Residents with Non-residents: Generally transactions which take place between the residents of the country with residents of other countries are recorded in the balance of payments.
3) A Flow Statement: A balance of payments is compilation of the flow of economic transactions of the country during the period and not a statement of the position as on a date. It is more like a funds flow of a company, rather than a balance sheet.
4) Periodicity: Normally balance of payment statement is prepared covering a period of one year. However depending upon the requirement of the government the statement may be prepared for shorter periods also such as six months, a quarter or even a month.
6. Fixed and Floating Exchange Rates:
a) Fixed Exchange Rates: Fixed exchange rates refer to the system under the gold standard where the rate of exchange tends to stabilize around the mint par value. Any large variation of the rate of exchange from the mint par value would entail flow of gold into or from the country. This would have the effect or bringing the exchange rate back to the mint par value.
b) Floating/Flexible Exchange Rates: Free or floating rates refer to the system where the exchange rates are determined by the conditions of demand for and supply of foreign exchange in the market. The rates are free to fluctuate according to the changes in demand and supply forces with no restrictions on buying and selling of foreign currencies in the exchange market.
Flexible exchange rates refer to the system where the exchange rates is fixed, but is subject to frequent adjustments depending upon the market conditions. Thus, it is not a free or floating rate with cent per cent flexibility, but is any system providing for adjustments as and when required.
Prior to the institution of International Monetary Fund, the international monetary system was following the fixed change rate system based on the international gold standard. Under the gold standard the value of the currency was kept equal to the value of a fixed weight of gold. Over the years the gold standard took three forms (a) gold currency standard, (b) gold bullion standard; and (c) gold exchange standard.
2. Exchange Rate System under IMF:
The International Monetary Fund was instituted with a avowed objective of facilitating smooth running of the international trade and betterment of all nations of the world. It was thought that a system of fixed exchange rates would be necessary for the smooth functioning of international finance. The original scheme of the International Monetary Fund therefore provided that:
a) Each member country should declare the external value of its currency in terms of gold and a currency pegged to gold. Most countries declared values of their currencies in terms of gold and US dollar. This was known as the par value of the currency.
b) The value of US dollar was fixed at USD 35 per ounce of fine gold. The USA committed itself to convert dollars into gold at the above official price.
c) Following the above, the monetary reserves of member countries came to consist of gold and US dollars. Thus US dollar got the position of a reserve asset.
d) Each country agreed to maintain the market value of its currency within a margin of 1% of the par value. Where the variation in the market is more than the permitted level, the country should take steps to devalue the currency to correct the position.
e) Members were free to devalue their currencies. But, if the devaluation exceeded 10% of the par value, approval of the International Monetary Fund should be obtained. The International Monetary Fund might approve it or advise a lower rate. However, it had no power to reject the proposal.
f) The International Monetary Fund granted short term financial assistance to its members to tide over their temporary balance of payments problems. For chronic problems the members were expected to use permanent solutions like devaluation.
3. Foreign trade and Foreign exchange:
International trade refers to trade between the residents of two different countries. Each country functions as a sovereign State with its own set of regulations and currency. The difference in the nationality of the exporter and the importer presents certain peculiar problems in the conduct of international trade and settlement of the transactions arising there from. Important among such problems are:
a) Different countries have different monetary units;
b) Restrictions imposed by countries on import and export of goods;
c) Restrictions imposed by nations on payment from and into their countries; and
d) Differences in legal practices in different countries.
The existence of national monetary units poses a problem in the settlement of International transactions.
The exporter would like to get the payment in the currency of his country. For instance, if American export machinery to Indian imports, the former would like to get the payment in US dollars. Payment in Indian rupees will not serve their purpose because Indian rupee cannot be used as currency in the United States. On the other hand, the importers in India have their savings and borrowings in India in rupees. Thus the exporter requires payment in the currency of the exporters country whereas the importer can pay only in the currency of the importers country. A need therefore arose for conversion of the currency of the importers country into that of the exporters country. Foreign exchange rates is the mechanism by which the currency of one country gets converted into the currency of another country.
The conversion of currencies is done by banks who deal in foreign exchange. These banks maintain stocks of foreign currencies in the form of balances with banks abroad. For instance, Indian Bank may maintain an account with Bank of America, New York, in which dollar balances are held.
4. Exchange rate:
The rate at which one currency is converted into another currency is the rate of exchange between the currencies concerned. If Indian Bank exchanged US dollars for Indian rupees at Rs.45 a dollar, the exchange rate between rupee and dollar can be expressed as USD 1 = Rs.45.
The rate of exchange for a currency is known from the quotation in the foreign exchange market. The banks operating at a financial center and dealing in foreign exchange, constitute the foreign exchange market. As in any commodity or stock market, the rates in the foreign exchange market are determined by the interaction of the forces of demand for and supply of the commodity dealt in, namely, foreign exchange. Since the demand and supply are affected by a number of factors, both fundamental and transitory, the rates keep on changing frequently and violently too.
5. Balance of payments:
Balance of payment is a record of the value of all transactions between residents of a country with outsiders. It constitutes the result of demand for and supply of foreign exchange for various purposes. Since the rate of exchange between currencies is determined by the forces of demand and supply, balance of payments is the fundamental factor in determining the exchange rates. A change in the balance of payments of a country will affect the exchange rate of its currency.
Definition: Balance of payments is the systematic summary of the economic transactions of the residents of a country with the rest of the world during a specified time period, normally a year. The following features of the balance of payments are implicit in the above definition:
1) Economic Transactions: The statement is a summary of economic transactions of the country with the outsiders. An economic transaction arises when values are exchanged or moved between nations.
2) Residents with Non-residents: Generally transactions which take place between the residents of the country with residents of other countries are recorded in the balance of payments.
3) A Flow Statement: A balance of payments is compilation of the flow of economic transactions of the country during the period and not a statement of the position as on a date. It is more like a funds flow of a company, rather than a balance sheet.
4) Periodicity: Normally balance of payment statement is prepared covering a period of one year. However depending upon the requirement of the government the statement may be prepared for shorter periods also such as six months, a quarter or even a month.
6. Fixed and Floating Exchange Rates:
a) Fixed Exchange Rates: Fixed exchange rates refer to the system under the gold standard where the rate of exchange tends to stabilize around the mint par value. Any large variation of the rate of exchange from the mint par value would entail flow of gold into or from the country. This would have the effect or bringing the exchange rate back to the mint par value.
b) Floating/Flexible Exchange Rates: Free or floating rates refer to the system where the exchange rates are determined by the conditions of demand for and supply of foreign exchange in the market. The rates are free to fluctuate according to the changes in demand and supply forces with no restrictions on buying and selling of foreign currencies in the exchange market.
Flexible exchange rates refer to the system where the exchange rates is fixed, but is subject to frequent adjustments depending upon the market conditions. Thus, it is not a free or floating rate with cent per cent flexibility, but is any system providing for adjustments as and when required.
