Wednesday, August 28, 2013

​Why Dollar rate pinches? - Times of India

Our imports are from all over the world. So, why does the dollar exchange rate matter so much?

Although the share of goods from the US in India's import basket was less than 5% last year , the dollar is the dominant currency in international trade and most of India's trade with other parts of the globe is also denominated in dollars . Foreign investment flows, whether foreign direct investment ( FDI) or foreign institutional investment (FII), are also largely in dollars. The exchange rate for most currencies in India is linked to the dollar-rupee rate .

How is the exchange rate determined?

The exchange rate of any currency is really its price in another currency . Like the price of any product in the market , the exchange rate is determined by the demand for and supply of each currency . Say, if there is more supply of dollars in India than its demand , the rupee will become stronger vis-a-vis the US currency . In the current situation , the demand for dollars is outstripping their supply for several reasons . These include the fact that our imports are much higher than exports and that FIIs have been pulling money out of Indian markets .

How does the market for dollars work?

Over 90 % of the trade in the forex market is between banks . Banks maintain their dollar stocks in a foreign bank or with their overseas branches . When anyone approaches a bank to either buy or sell dollars , the bank quotes a price . The price at which the bank buys a currency will always be lower than the selling price , as is the case with a trader in any other commodity . It determines these prices based on its assessment of how much the market will bear . Of course , what the competitors are offering is also a factor . The bulk of transactions in the currency market involve the same set of traders buying and selling . For instance , in April , the daily interbank volumes in the spot forex market ranged between $8 billion and $10billion . Of this, only around $2 billion was on account of merchant trade . Global currency trading (across countries ) is estimated at $4-5 trillion (around Rs 340 lakh crore ) a day .

How does trading take place?

Like most modern financial markets , the dollar is traded electronically . Earlier , banks in India used a closed electronic dealing system where they offered two-way or buy-sell quotes on the currency . Just as stock brokers quote a price for a stock, dealers quote a price for a currency pair such as dollar-rupee .

So, how does a manufacturer plan given the fluctuating rates?

There are a variety of ways in which companies can 'fix' their exchange rate . They can enter into a forward contract with a bank which agrees to sell or buy dollars in future at a predetermined rate . (For instance , Company A may enter into a contract with Bank B that it will buy $1 million on December 1 at , say , Rs 75.) They can buy currency options in the derivatives segment of the stock exchange . Forwards and futures are nothing but hedging tools, which help companies minimise their currency risks . Of course , it also means that any possible gains from rates moving in their favour in the spot market have to be fore gone . In the above example , if the rupee appreciates to 60 to a dollar , the company would miss out on the favourable exchange rate .

What are non-deliverable | forwards?

Investors in emerging markets such as India want to hedge against currency risks outside the country . This is out of fear that the government may place capital controls as happened in Mexico in 1982 . In the NDF, investors who bet on rupee futures will get the equivalent amount in dollars on the due date , say , a month or three months later . The NDF market is seen to have greater depth than the futures contracts offered on Indian stock exchanges as large foreign banks trade abroad . Since these markets exist in places such as Singapore , Indian regulators have no control over them . With Indian companies venturing abroad , the scale of the NDF market has now grown .

How does the RBI intervene?

In recent years , RBI intervention has largely been through public sector banks . The central bank offers dollars to state-owned banks at a price it fixes and these are then sold in the foreign exchange market to prevent a steep climb of the US currency . Alternatively , when the rupee is appreciating , public sector banks buy up dollars from the market .

Why is the rupee falling so sharply?

Markets anticipate events and take positions accordingly . The fear of a oil price spike due to a possible USled attack on Syria , has made investors nervous about the impact on countries such as India . The rupee , which was already under pressure , due to a weakening economic situation and global factors , was amongst the worst hit on Wednesday .

Is it not possible to curb speculation?

RBI has put restrictions on banks and on exporters and importers on trading in dollars . It has barred them from buying dollars in anticipation of future demand . But, exporters can still speculate by putting off bringing their earnings home , in anticipation of a further weakening of the rupee . Similarly , importers can pay early to avoid spending more rupees to buy the same amount of dollars later . Also, the size of the unregulated non-deliverable forward market has grown and is now around 70% of the size of the domestic market , compared to 20% a decade ago.
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