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Economy A story of forex, currency conversion, rupee depreciation, inflation, subsidies, etc. Again in the fond memories of Dev Anand. In writing this story so that the newcomers can get an idea about forex, currency conversion, rupee devaluation, inflation, subsidies etc (be careful, full of technically not-so-correct examples just to give you a broad idea of ​​what ails Indian Economy) Ok here it goes .. Investor: Faith won and lost Enter an American Mr. James. Thanks to the American recession, he decides to invest outside the US and comes to India with a bag full of green dollars after being assured by RBI and Commerce Secretary that the environment in India is very conductive for businesses. Please come, give us your dollars, we'll convert it to rupees. He (full of confidence) converts his dollars at the rate of Rs.40. Now James is looking for land to open an office or factory somewhere near a large city in India. But the price of land is so high thanks to the black money that it makes no sense to buy a property. He says ok let me just rent some readymade buildings and I'll run a small i-phone production company. But the electricity turns off for hours and hours. James: ok, i'm buying a diesel generator like any other industrialist in this field. The diesel price is also rising, the profit margin is falling. Adding insult to the injury, its workers have gone on strike. The workers are demanding a wage increase because of the ever-increasing prices of milk and gasoline, and James is unable to end the dispute, resulting in a long (and expensive) legal battle. The factory has now been closed for weeks and months. James: Let me set up a coffee shop to pay lawyers. But the price of raw materials (milk, sugar, gas) is also rising. Add the bribe he has to pay to local goons, cops, and community corporators. If he increases the selling price of each mug, it will drastically reduce the number of customers. Again, hardly any profit margin. In addition, often a political outfit or another, calling for a strike band to protest for the creation of separate state or against inflation or corruption or lokpal or just because someone suggested their political leader. James dares to open his shop on this 8216Bandh day, 8217 and he is severely beaten by the political gods, his coffee house ransacked while the police are silent. His calls his pal Allen in America, warning him not to invest in India. Currency Speculation Forex Market In the local beer bar in California, Allen overhears some conversations between drunkards that soon IMF and World Bank will give great financial aid to the ailing Greeks and Portugal, and their economies will be back on track. If you put money into stock exchanges or real estate in these countries at this point, it could get a nice return of 40-50 a year. Allen remembers a Bollywood film he saw on Youtube with English subtitles, the disabled old man had given deep and universally applicable management advice in this film: Lohaa Garam hai maar do hathoda Allen is immediately on the Forex market , with his pocket full of dollars to convert them into euros. Crude Oil Bill Curious, Chairman of the IOC (Indian Oil Corp.) also waits for the forex market there, with a suitcase full of rupees. He is in desperate need of the dollar for King of Saudi not to take payment in rupees for the crude oil sold. IOC Chairman: dude got every dollar come on man. I need you please. IOC Chairman: You know the routine rate. 1 for 40 rupees. Allen: Hell no. I don't sell. My best friend didn't tell me. IOC Chairman: ok ok, like about 45 rupees for a dollar. IOC Chairs: 50 IOC Chairs: 52 Allen: ok, you have a deal. RBI boss: what happens in the gods name 52 rupees for a dollar How are we supposed to import crude oil at this expensive rate Finance Minister (FM): hey look on the bright side, although our imports are getting more expensive but now our exports are making more money. It's good for call centers and textile exporters. And then they use the money to buy items in Indian market there will be more demand create more jobs in business. Trick the theory. RBI: Wait a minute Nobody is going to buy anything under this high inflation. So whatever extra profit the call center owner makes thanks to that rupee devaluation, hell lock it into landline banks or pension funds and hell wait and watch for prices go down before you make a big purchase. This trickle down theory is not as linear and straight forward as you think. Back to the point, we need dollars to finance the import of crude oil. Treasury Secretary: No problem. You have over $ 200 billion forex reserve under your control. Leave them in the market. RBI Head: Never. I'm saving you up for the rainy day. God forbid, if the situation gets worse, our pockets will be completely empty. What if a war with Pakistan or China breaks out, how are we going to buy extra oil for our warplanes and battle tanks during this crisis, when our forex reserve is wasted like this finance minister: damn it, when gasoline prices and diesel are down because of that rupee If devaluation increases, so will truck transport costs and so will prices of milk, eggs, fruits and vegetables. Spider-man's Uncle Ben before his untimely death had said that with great power comes great responsibility, and great pawar comes great slappings. Please man, do something we need green dollars to finance the oil bills. I've won UP election. RBI Chief: How About You Stop MNREGA That will stop a lot of corruption, black money generation and the resulting inflation and price rise. FM: You're kidding, right How am I supposed to win elections without MNREGA centrally sponsored welfare system is the only brand USP of our party RBI: Ok, how about disinvestment sell some of your shares in SAIL, Coal India and other public sector companies. FM: Yes we can do that, but wait Madam-ji and NAC (National Advisory Council) said the disinvestment money is going to National Investment Funds out of which it can be spent on more schemes like MNREGA. RBI: ok the 2G and CWG corruption can then use money from Raja and Kalmadi to fund the oil bill. FM: lolz, get on with people, be serious. Hey wait. How about you print 10 suitcases of rupees in your printing press. Then I go to Forex market and get them converted into dollars. RBI: Yes, that could work. Only problem is that the guy like buying these suitcases from you in exchange for dollars. He could come back, buy all the onions and potatoes from our market with the same printed rupees and bring them back to his home. That would lead to further inflation because fewer products will remain in our market. FM: no no UP electionno more inflation. RBI: I understand your compulsions, but I cannot release dollars from my reserve. But how about you arrange for dollars 8230 ... you know something like about FDI Like about 51 FDI in retail, should that attract a lot of overseas gamblers with pockets full of dollars they will be desperate to convert it to rupees. Finance Minister: hmminteresting. Economic Survey Ch6 Balance of Payments, Forex Reserves, Currency Exchange, NEER, REER What is the Balance of Payments Import, Export (always negative because we export less and import more oil n gold, so we've trade deficit.) Income from abroad (interest, dividend payments for foreign Direct investment, FII in the USA etc.) Transfer (gift, remittances from NRI to their families etc. always positive for India because of the large diaspora abroad.) Foreign investment in India (FDI, FII, ADR, direct purchase of land, assets) . Foreign commercial borrowing, outside support etc. Since we want to track the flow of cash, so if Americans invest in India (via FDI, FII, ADR etc.) we add it as (), and if Indians invest in USA ( via FDI, FII, IDR etc.) we add it as (-) and get the final number for foreign investment. Same goes for anything in the balance of payments (wire transfers, external commercial borrowing whatever). In short, BoP we track the incoming and outgoing money. For India the current account deficit (negative number) and the capital account has been in excess (positive number). The BoP booking system is similar to double entry bookkeeping. Therefore, theoretically, the balance in the current account and the balance in the capital account should be identical (ignoring the - signs). In other words, if there is a deficit in the current account, there must be an equal surplus in the capital account. Why Why BoP 0 in Theory Assume there are only two countries India (rupees) and USA (dollars). And there are no forex agents or middlemen, taxes, regulation, cricketers, politicians, Saah-Bahu series anything8230 Now Indian importer is buying Apple6 phones worth 10 billion US from American exporter. In the absence of a forex agent, the Indian importer pays 500 billion Indian rupees to this American exporter. (Assuming 150 Rs.) Means that a lot of rupee currency has gone out of the Indian system via current bill. But this American exporter has no use of Indian rupees. He lives in the US, he can't even buy a burger from local McDonalds shop with Indian rupees. So what can he do? He can import something else from India (e.g. raw material, steel and plastic for the further production of Apple6) our rupee currency comes back to India via current bill. He can invest this Indian currency to set up a factory or a joint venture in India (our rupee currency comes back to India via capital account) He can buy some stocks or bonds in India. Our rupee currency is coming back again. He can find a second American who wants to import something from India, wants to invest in India. Apple6 guy can sell his rupee currency to that third American companion Rs.501 or Rs.491 or Rs.991 (depending on the desperation of the 2nd American companion). In short, if rupee runs out, it has to come back. (The same for dollars, from an American point of view). Hence the current account capital account ZERO (balance of payment), at least in theory. But in reality, RBI or financial authorities never have complete details of all financial transactions and exchange rates to keep them fluctuating. Hence there are statistical discrepancies, errors and omissions and. So BoP is expressed as: current account account net errors and omissions 0 (balance of payments). In the IMF definition, we can output this as a checking capital account. Financial account balance sheet position 0 Ok then it means that a country can never have a surplus (or a deficit) in the balance of payments. Well, a country can have a temporary BoP surplus or deficit. Because BoP is calculated quarterly and annually. There's a good chance the American Apple6 exporter may not push back all of those 500 billion Indian rupees in India within that timeframe. Second, Indian government can put some FDIFII restrictions so that Apple6 exporter (or that third American guy) can't invest in India again even if they want to. But in the long run the system will even out. For example Apple exporter is going to find some fourth American importer and convince him to pay Indian exporter in rupee currency and thus apple man will get rid of his 500 billion rupees by having them with the American importer dollar Or the apple exporter will find some NRI live in USA. This NRI wants to send money (dollars earned by working in the US) to his family back in India (preferably in Indian currency) so that this NRI will be ready to exchange his dollar savings with the Apple exporters rupees. There are many other options and combinations, but the point is, in BoP, whatever currency goes out of the country, will come back into the country. Convertibility For example, let's say you want to import a Dell computer from the United States. And the American exporter only accepts payments in dollars. If you can easily convert your rupee to dollars, it means that the rupee is fully convertible. And rupee is fully convertible in terms of current account transactions (e.g. import, export, interest, dividends). But rupee is partially convertible for capital account transection. (Originally this means that if an Indian wants to buy assets abroad or borrow them via FDIFII or via debt financing, he cannot do so beyond the limits prescribed by RBI (e.g. American wants to convert his dollars (FERA) 1973: Foreign Exchange Act, 1973 (FERA), 1997: Tarapore Committee (RBI), member of the RBI,, Had recommended India to have full capital convertibility (which means that anyone can voluntarily go from local currency to foreign currency and back without any restrictions by government or RBI May.) 2002: Government replaced FERA with the Foreign Exchange Management Act (FEMA). Although full capital account convertibility is not yet in place. Full capital convertibility has both advantages and disadvantages. But that'd need another article. Let's get back to the topic, let's see the sixth chapter of the Economic Survey: Balance of Payment, Exchange Rates, etc. Rupee-Dollar Exchange Rate How does the system work of fixed exchange rates and how the market-based exchange rate system works in the Bretton Woods article. Click me somehow, we can construct a wrong technically wrong model in order to understand the market-based exchange rate system, again: Take the following things There are only two countries in the world, India and America. India has rupees currency. Indian farmers don't grow onions. America has no currency, they trade onions. The rate is 1 kg of onions. 50 First situation. American investor believes that the Indian economy will increase. If we invest in India (FDIFII), well make good profit. So they are more eager to convert their onions into Indian rupee currency. So they even agree to sell 1kg of onions at Rs.45. (And then buy Indian reverse convertibles worth Rs.45) Earning rupee strengthened against onion (dollar). During this time, RBI Governor also buys 300 billion pounds of onions from the Forex and stores those onions in his refrigerator. (Why Onions Are Selling Cheap And Why Onions Are Selling Cheap Since there is surge in investment in India by American investors.) Ok everything is going well and smoothly. Now add third country to our fake model: UAE. Second situation. UAE has raised crude oil prices and they do not accept rupee currency. You also want to pay in onions. 1 barrel of crude oil costs 132 kg of onions. India is eagerdesperate for oil because if we don't have crude oil we can't get gasoline, this whole economy will collapse. So India would agree to buy 1kg of onion for even Rs.55 (from American or Forex agent or whoever is willing to sell its onions). Then India can give these onions to some sheikhs from UAE and import crude oil. Third situation: The Sheikh of UAE is even greedy, he demands 200kg of onions for 1 barrel of crude oil. Now buy 1kg onion for Rs.59 because those with onion surplus (sellers) know India like it or not, it has to buy onions to pay for the crude. So rupee against onion has weakened (dollar.) If such a situation If it continues, then there will be great inflation in India (because crude oil becomes expensive expensive expensive expensive expensive milk sales and everything else transported by petrol diesel becomes expensive.) Now RBI governor decides to become the hero and save the fall of the rupee against onion. So he loads a couple of tons of onions in his truck and drives it to the forex market. Result: onion supply has increased should the price go down. Now onions little cheaper: 1 kg onion 53 Rs. So RBIs intervention in the forex market has led to the restoration of the rupee. Ok, so what do we get from this story RBIs intervention to buy foreign currency while surge in capital investment leads to the build-up of (foreign exchange) reserves that self-insurance offers against external vulnerability of the rupee. When RBI sells its foreign exchange reserves, the fall will come (stop) from rupee. Higher foreign exchange reserves restore investor confidence and can lead to an increase in foreign direct and indirect investment flows, which stimulate growth and help bridge the current account deficit. Building Foreign Exchange Reserves Before 1991, India followed the license quota inspector (and suitcase) raj and the import substitution strategy. (Nicely explained Grade 11 NCERT textbook.) During this era, foreign companies could not invest in India. Imported products such as radio camera wristwatches attracted heavy customs duty.(And that led to the rise of smugglers and mafias and the Bollywood films that romanticized their criminal life). On the other hand, thanks to the license quota inspector (and suitcase), the private Indian companies were raj large or efficient enough to compete in the international market so export was also low. Result. During this time incoming money (via export, investment) was very low. Hence RBI could not build up huge forex reserve. (If the onion supply is low, its prices will be high) Ultimately, in 1991, the forex withdrawals from India were exhausting. Eventually India had to pledge its gold to the IMF and get loans. Then India had to open its economy to private and foreign investment. Remove the license quota inspector raj etc. to encourage the incoming flow of dollars and other foreign currencies .. all these LPG reforms. (Though suitcase raj continues because the Mohans in the system are blinded by totally awesome people like A. Raja.) Fast-forward: Now we've got a trillion dollar economy, our software and automotive companies are recognized worldwide blah blah blah. But the lesson learned: RBI should have a good foreign exchange reserve. Hence, after RPI reforms, RBI has bought dollars, pounds yen, etc. from the foreign exchange market whenever FIIFDI inflow is high. Because during such a situation, foreign investors are more anxious to convert their dollars into rupee currency, which is why rupee is traded at a higher rate, e.g. B. 1Rs.49 But after the global financial crisis, RBI stopped actively building up its foreign exchange reserves. Today RBI intervenes in the foreign exchange market just to stop the excess volatility (fluctuation) in rupee exchange rates. However, there was a sharp decline in the rupee in 2011-12. Then RBI had to sell $ 20 billion worth of foreign currency. (So ​​the demand for foreign exchange would decrease and the rupee would stop). Likewise in 2012, RBI also had to sell its foreign exchange reserve worth $ 3 billion to prevent the rupee from falling. (In June 2012 the rupee had become very weak: 1 57 rupees. Thanks to the RBI - and government interventions, it returned to normal 53-54 levels in late 2012.) FOREIGN PROVISIONS Foreign currency assets (US dollars, euros, pounds sterling, Canadian dollar, Australian dollar and Japanese yen etc.) Gold, Special Drawing Rights (SDR) of the IMF Reserve Tranche Position (RTP) in the International Monetary Fund (IMF) The amount of the foreign exchange reserve is given in US dollars. Hence, India's forex reserve decreases when the US dollar values ​​itself against major international currencies and vice versa. RBI gains foreign exchange reserves through the purchase of foreign currencies (via interventions in the foreign exchange market Financing from the International Bank for Reconstruction and Development (IBRD), Asian Development Bank (ADB), International Development Association (IDA) etc. Income, interest income China has the largest forex reserve ( 3300 billion US dollars) India is the 8th place (close to 300 billion USD) countries with the largest forex reserves Why volatility in rupee volatility varies in something over the given time, if today SENSEX is 12000 points, tomorrow it is about 200 points and day after it drops by 300 points etc..They we say the market is volatile. If morning shifts SSC paper is too easy, but evening shifts SSC paper is also the same if there is too much fluctuation in dollar to rupee exchange rate Let's say the rupee is volatile. The rupee experienced unusually high volatility in 2012. Why 1: Import-Export The demand for Indian goods and Tue Services declined due to the eurozone crisis America has not fully recovered. On the other hand, the cost of importing very high due to the oil and heavy gold import (due to high inflation). Equally high inflation commodity services costly for export. If he increases prices then his export product will be less competitive than cheap China made material. In total foreign investment in India, majority comes from FII (and not from FDI). FII money is hot, it lets up quickly when FII investors believes that Indias market is not giving good returns and or some other xyz countrys market is giving better returns. There is week-to-week variation in such FII inflows and outflows. Hence, it leads to changes in the rupee-dollar exchange rate. 3: Dollar is Strengthened US Treasuries are the safest investment. During the peak of the eurozone, Greece crisis, big investors started pulling money out of Europe and investing it in US Treasuries. Demand of dollars increased. So other currencies would automatically weaken against the dollar. 4: Politics Paralysis For the past couple of years the Indian government has been lazy about environmental project clearance, land acquisition, retail FDI, pension insurance, insurance etc. which have caused foreign investors to lose faith in the Indian economy slowing down in FII tributaries. (Besides the government doesn't allow more FDI in retail annuity insurance etc. so FDI inflow doesn't increase). 5: Risk to Risk from the previous article on Debt vs. Equity, Treasury Bonds Safer Than Stocks (stocks). But if an investment is safe, it will not offer good returns. When foreign investors feel confident, they pose risks to the behavior they invest in stocks, especially in developing countries. (Which are risky, but offer more profit). But when foreign investors are not confident they show risk behavior, they usually invest back in US Treasuries or gold. In India, the majority of foreign investment comes from FII (and not FDI) and FII investors are more prone to portraying this risk-on-risk-off behavior. They pocket their money quickly, they take out their money quickly. Thus, the Indian rupee exchange rate becomes volatile against the dollar. Therefore, the Indian government needs to inspire and support the confidence of foreign investors in order to prevent the fall of the rupee. RBI intervention in forex market, can't help above a level. How did rupee recover rupee is weakening against dollar, it means that the demand of the rupee is less than the demand for the dollar. So how did RBI and government fix it exchange rate of other emerging countries NEER and REER Why is REER important External Debt World Bank has published 8216International Debt Statistics, 2013 8216 It contains the debt figures for 2011. According to these statistics, in 2011 India was in absolute foreign debt after China, the Russian Federation and Brazil. At the end of March 2012, the external debt was US $ 345 billion (close to 17 lakh crore rupees). India's external debt is high because of the higher NRI deposits (since NRIs don't get much return on their dollar savings in American banks, they prefer to invest them in India). External corporate bonds (from Indian companies) Borrowers in India and other emerging markets are keen to borrow in foreign currencies (dollars and euros). Because in USEU right now the market is not many domestic loan taker entrepreneurs, hence their banks investors dont mind loans to foreigners (that is Indian other Asian businessmen) at very low interest rate and longer EMIs. But such loans are not always helpful, however, especially during times of high currency volatility. For example, if Indian entrepreneurs had borrowed loans from USA when 149 rupees but after several years when 157 rupees then hell have to repay more. This affects not only him, but also India's BoP. FDI Restrictiveness Index (FRI) Manufactured by OECD. A score of 1 indicates a closed economy and 0 means openness. China is ranked # 1 (it is the most restrictive country) India is the fourth Foreign Direct Investment (FDI) will attract foreign portfolio investment mainly because FDI is expected to use modern technology, management practices and is long term in nature investments. The government has liberalized FDI standards for overtime. As a result, only a few sensitive sectors fall into the prohibited zone and FDI is permitted in whole or in part in the remaining sectors. FDI: Defense Offset There are currently 26 FDI approved in the Indian defense sector. It also requires FIPB approval licensing under the Industries (Development Amp Regulation) Act, 1951 which has guidelines for ADI to follow in the production of arm-amp ammunition. India needs to open up the defense sector to gain access and ensure technology transfer. The existing FDI policy for the defense sector provides for an offset policy. (That is, the foreign company has to commission part of its work to local domestic actors, e.g. foreign direct investment in multi-brand trade, so that foreign companies have to buy 30 percent of the small businesses.) This equalization policy makes the balance of payments softer effects and development of local technical skills. Recently government revised the offsets policy for the defense sector. Yet it has not shown any visible direct or indirect benefits to the Indian domestic defense industry. CHALLENGES AND OUTLOOK while capital inflows in India were sufficient to securely fund the CAD. But the majority of capital flows are above FII (i.e. volatile) this has led to financial fragility and is reflected in the rupee exchange rate volatility. We cannot significantly increase our exports in the short term because they depend on the recovery and growth of the partner countries (USA, EU). And that can take some time. Therefore, our focus is on curbing imports, mainly by making oil prices more market determined (expensive), and curbing imports of gold. We should focus more on foreign direct investment and open up the sectors further. Finally, external commercial borrowing must be carefully monitored. Miscellaneous Facts Three top countries FDI comes to India from: Mauritius, Singapore and UK Global Economic Perspectives This report is published by the World Bank. Mock question Which of the following is not a part of the financial account FDI FII Remittances External Commercial Loans Which of the following is not a part of the current account Import Export External commercial loans Interest, dividends on FII India has deficit in current account capital Both None India has surplus in Current Account Financial Account Both No India8217s Official Foreign Exchange Reserve doesn8217t are Foreign Currency Assets (FCA) (US Dollars, Euros, Pounds Sterling, Canadian Dollars, Australian Dollars and the Japanese Yen etc.) Gold Silver Special Drawing Rights (SDRs) How can RBI build up its foreign currency reserves by buying them of foreign exchange through funding from World Bank, ADB etc. Both None Which of the following countries has the second largest foreign exchange reserves in the world India France Japan USA Among the countries with the largest foreign exchange reserves, India in second place third fifth eighth rupee will strengthen against dollar if Government FDI Poli tik government eases on FII investment to raise the ceiling both no correct statement NEER is calculated by RBI REER, is calculated by Ministry of Finance both no REER catches difference in inflation between India and their trade partners of the external competitiveness of Indian products Both none Which of the following Currency is not part of REW-6 calculation Hong Kong dollar Japanese yen Pound sterling Canadian dollar wrong game S. Korea: won Mexico: Peso Argentina: Peso S. Africa: Baht Which of the following is not published by World Bank International Debt Statistics 2013 FDI Restrictiveness Index Global Economic Prospects All Above FDI Restrictiveness Index from IMF ADB OECD World Bank Majority of FDI in India, comes from Mauritius Germany USA None of the above Mrunal recommends being released. L6P7: Chinese Forex Reserve, Undervalued Yuan & Merchantile Policy: How: 8 2015. Language: Hindi, Topics Covered: 1. How does China's Mercantile policy and labor abuse help trade surplus 2. How China keeps its yuan undervalued 3. How did China build large forex reserve nearly 4 trillion 4. What are the benefits and challenges in maintaining a large forex reserve 5. Economic survey has recommended India to create a forex reserve worth from 750 billion to 1 trillion through current account surplus-how can we do that 6. how can big forex is a help with soft diplomacy and powerpoint project exports available at mrunal. orgdownload Exam utility: UPSC CSAT, preliminary, network, CDS, CAPF, Bank, RBI, IBPS, SSC and other competitive exams, IIM, XLRI, MBA interviews and GDPI Faculty Name: Mrunal Patel Location: Sardar Patel Institute of Public Administration (SPIPA ), Satellite, Ahmedabad, Gujarat, India