Forex Reserves Consist of:

• Bank deposits

• Gold

• Special drawing rights (SDRS)

• Reserve tranche position (RTP)

• Foreign currency assets (FCA)

• Government securities

SDR

• SDR is an international reserve asset, created by the IMF in 1969.

• Value of the SDR is based on a basket of five currencies- Dollar, Euro, Renminbi, Yen, and Pound Sterling.

• It is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.

FIXED EXCHANGE RATE

FLOATING EXCHANGE RATE

MANAGED FLOATING RATE

Complete intervention of Authority (government or central bank) in determination of the currency exchange rate.

Market forces(demand and supply) determine the value of currency

No role of authority

Exchange rate is largely determined by market forces.

In crisis, central banks may intervene to stabilize the exchange rate

Nominal Effective Exchange Rate (NEER)

Real Effective Exchange Rate (REER)

Weighted average of bilateral nominal exchange rates of the home currency in terms of foreign currencies

Weighted average of nominal exchange rates, adjusted for inflation.

It is the exchange rate of one currency against a basket of currencies, weighted according to trade with each country (not adjusted for inflation).

Is calculated on the basis of NEER.

Captures inflation differentials between country and its major trading partners and reflects the degree of external competitiveness

Partial Convertibility:

• Portion allowed by the government which can be converted into foreign currency with least restrictions.

• Union Budget for 1992-93, introduced it on current account under Liberalized Exchange Rate Management System (LERMS)

• Also known as Dual exchange system.

• Presently partial convertibility still operational on capital account.

Full Convertibility:

• Freedom to convert domestic currency into any foreign currency and vice versa without any regulatory intervention.

• Dual exchange rate system got automatically abolished and LERMS was now based upon the open market exchange.

• In 1994, the Government of India declared full convertibility of Rupee on Current account.

Tarapore Committee I (1997) and II (2006):

• Constituted by the RBI for suggesting a roadmap on full convertibility of Rupee on Capital Account.

Current Account

Invisible

Visible

Goods(+)

Services [+)

Income

1. Dividend

2. Interest

3. Profit

Transfer [+]

1. Gift

2. Donation

3. Remittance

Capital account [+]

Investment [+]

1.Sovereign 2.Commercial

NRI account [+]

1. Gift

2.Donation 3.Remittance

Loan (+)

1 FDI 2. FII/FPI

CURRENT ACCOUNT

CAPITAL ACCOUNT

Meaning

• Records imports and exports of visible and invisibles

• Short term implication transactions

• Covers only earnings and spending.

• Excludes any borrowings and lending.

• Shows capital expenditure and income for country

• Long term implication transactions

• Only includes borrowings and lending by a country

Components

• Visible trade(Export and Import of goods-Merchandise transactions )

• Invisible trade(Export and Import of services)

• Unilateral transactions

• Direct Investment (FDI)

• Portfolio Investment (FPI)

• Loans / External commercial borrowing (ECB)

• Non-resident’s investment in Bank, Insurance, Pension schemes.

• RBI’s foreign exchange reserve

Deficit (CAD)

• If the value of the goods and services imported exceeds the value of those exported.

• Current Account deficit = Trade gap(export – import) + Net current transfers (foreign aid) + Net factor income (Interest, Dividend)

• When more money is flowing out of a country to acquire assets and rights abroad

Surplus

• If the value of the goods and services exported exceeds the value of those imported.

• Money is flowing into the country, but these inflows reflect changes in the ownership of national assets by way of sale or borrowing.

Convertibility

• Current account convertibility relates to the removal of restrictions on payments relating to the international exchange of goals, services and factor incomes.

• Capital account convertibility refers to a liberalization of a country’s capital transactions such as loans and investment.

Current status

• Allowed Full convertibility

• Only Partial convertibility