Final Mono Sir

8/7/2019 Final Mono Sir

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EXECUTIVE SUMMERY

Foreign exchange reserves are the foreign currency deposits and bonds held by central

banks and monetary authorities. These are assets of the central banks held in different reserve

currencies , mostly the US dollar, and to a lesser extent the euro, the UK pound, and the

Japanese yen, and used to back its liabilities. This study is done to know the impact of FOREX

reserve on the economic indicators like GDP, inflation, Balance Of Payment (BOP), interest

rates and the currency exchange rates.

The accumulation of FOREX reserve is comparatively high, compare to 1980s and

before. The foreign investors started investing more after the liberalization and globalization of

the Indian economy in 1991. These policies made a significant change in economy that brought

many MNCs, foreign investors to India. With the entry of foreign investments and MNCs

created many jobs. More people became employed, this resulted increase in the purchasing

power. With the increase in purchasing power the demand for the goods and services increased.

With all these the growth (GDP) of the nation also increased. The increase in purchasing power

caused the imbalance in demand and supply of goods, which results in high inflation rate. RBI

plays a major role in maintaining inflation. When inflation becomes higher or lower than certain

level, to control inflation RBI changes monetary policy (i.e. when there is high inflation it

increases the interest rates, which sucks money from the market and vis--vis).

The inflow of foreign investments depends on the government policies and also the

economic condition of the country. When the interest rates are high with comparatively low

inflation and also the growth is good, then the inflow of foreign investment is comparatively

high. The more investments make the home currency weaker and foreign currency stronger. The

investors involved in arbitrage they make use of the conditions and they sale foreign currency

and buy home currency. This process will bring equilibrium in currency rates and helps to

maintain a comparatively stable value for home currency.

The BOP also plays a crucial role in the FOREX reserve of the country. The BOP helpsin settling the imports and exports. The BOP also includes NRI deposits, invisible receipts and

etc. The increase in any of these components adds to our FOREX reserve.Along with GDP,

THE OXFORD COLLEGE OF BUSINESS MANAGEMENT Page 1


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Inflation, BOP, the other things like Currency Exchange rate, CRR, PLR also contribute to

increase reserve of the country.

By looking into all these aspects, we can make out how the FOREX reserve of the

country indicates the health of nation. Also by looking into data of economic indicators the

effect of the reserve on the economy can be known. The small fluctuation in the indicators some

time leads to large variations.



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CHAPTER 1

EVOLUTION OF FOREX IN INDIA

The gradual liberalization of Indian economy has resulted in substantial inflow of foreign

capital into India. Simultaneously dismantling of trade barriers has also facilitated the integration

of domestic economy with world economy. With the globalization of trade and relatively free

movement of financial assets, risk management through derivatives products has become a

necessity in India also, like in other developed and developing countries. As Indian businesses

become more global in their approach, evolution of a broad based, active and liquid FOREX

markets is required to provide them with a spectrum of hedging products for effectively

managing their foreign exchange exposures.

In India, the economic liberalization in the early nineties provided the economic rationale

for the introduction of FOREX. Business houses started actively approaching foreign markets

not only with their products but also as a source of capital and direct investment opportunities.

With limited convertibility on the trade account being introduced in 1993, the environment

became even more conducive for the introduction of these hedge products. Hence, the

development in the Indian FOREX derivatives market should be seen along with the steps taken

to gradually reform the Indian financial markets. As these steps were largely instrumental in the

integration of the Indian financial markets with the global markets.

Since early nineties, we are on the path of a gradual progress towards capital account

convertibility. The emphasis has been shifting away from debt creating to non-debt creating

inflows, with focus on more stable long term inflows in the form of foreign direct investment

and portfolio investment. In 1992 foreign institutional investors were allowed to invest in Indian

equity & debt markets and the following year foreign brokerage firms were also allowed tooperate in India. Non Resident Indians (NRIs) and Over- seas Corporate Bodies (OCBs) were

allowed to hold together about 24 percent of the paid up capital of Indian companies, which

was further raised to 40 percent in 1998. In 1992, Indian companies were also encouraged to



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issue ADRs/GDRs to raise foreign equity, subject to rules for repatriation and end use of funds.

These rules were further relaxed in 1996 after being tightened in 1995-

-Following a spurt in such issues. Presently, the raising of ADRs/ GDRs/ FCCBs is allowed

through the automatic route without any restrictions.

Foreign currency Assets as a % of total Reserves in the post & Pre Economic reforms phase:

40

60

80

100

FCA%of

TotalForexRese

1980 1985 1990 1995 2000 2005

Year

FDI norms have been liberalized and more and more sectors have been opened up for

foreign investment. Initially, investments up to 51 percent were allowed through the automaticroute in 35 priority sectors. The approval criteria for FDI in other sectors was also relaxed and

broadened. In 1997, the list of sectors in which FDI could be permitted was expanded further

with foreign investments allowed up to 74 percent in nine sectors. Ever since 1991, the areas

covered under the automatic route have been expanding. This can be seen from the fact that

while till 1992 inflows through the automatic route accounted for only 7 percent of total inflows,

this pro- portion has increased steadily with investments under the automatic route accounting

for about 25 percent of total investment in India in 2001.

In 1991, there were also modifications to the limits for raising ECBs to avoid excessive

dependence on borrowings that was instrumental for 1991 BOP crises. In March 1997, the list of

sectors allowed to raise ECBs was expanded; limits for individual borrowers were raised while



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interest rate limits were relaxed and restrictions on the end-use of the borrowings largely

eliminated. In 2000, the Indian Government permitted the raising of fresh ECBs for an amount

up to US$ 50 million and refinancing of all existing ECBs through the automatic route.

Corporate no longer had to seek prior approval from the Ministry of Finance for fresh ECBs of

up to US$ 50 million and for refinancing of prevailing ECBs.

While the inflows from abroad have been freed to a large extent, outflows associated

with these inflows like interest, profits, sale proceeds and dividend etc are completely free of any

restriction. All current earnings of NRIs in the form of dividends, rent etc has been made fully

repatriable. But convertibility in terms of outflows from residents, however, still remains more

restricted although these restrictions are gradually reduced. Residents are not allowed to hold

assets abroad. However, direct investment abroad is permissible through joint ventures and

wholly owned subsidiaries. An Indian entity can make investments in overseas joint venturesand wholly owned subsidiaries to the tune of US$ 100 million during one financial year under

the automatic route. At the same time investments in Nepal and Bhutan are allowed to the tune

of INR 3.50 billion in one financial year. Units located in Special Economic zones (SEZs) can

invest out of their balances in the foreign currency account. Such investments are however

subject to an overall annual cap of US$ 500 million. Indian companies are also permitted to

make direct investments without any limit out of funds raised through ADRs/GDRs. Recently

mutual funds have been allowed to invest in rated securities of countries with convertible

currencies within existing limits.

RBI has been transparent in making available, in public domain, appropriate data relating

to FOREX market and those resulting from RBI operations in the foreign exchange market. RBI

disseminates the daily reference rate which is an indicative rate for market observers through its

website. The movements in foreign exchange reserves of the RBI are published on a weekly

basis in the Weekly Statistical Supplement (WSS). WSS also carries data on exchange rates of

rupee against some major currencies. The monthly Bulletin of RBI gives data regarding

purchases and sales of foreign currency undertaken by RBI against the rupee. The data regardingthe Balance of Payments and the External Debt profile of the country is put out on a quarterly

basis. RBI has already achieved full disclosure of information pertaining to international

reserves and foreign currency liquidity position under the Special Data Dissemination Standards



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(SDDS) of IMF. With the concurrence of Government of India, RBI decided to compile and

make public half-yearly reports on management of foreign exchange reserves for bringing about

more transparency and also for enhancing the level of disclosure in this regard. The first such

report with reference to September 30, 2003 was put in public domain through websites of both

the Government of India and RBI in February 2004.

INTRODUCTION

Foreign Exchange Reserves (FER) is the surplus money or capital that a country parks

or maintains in the foreign country in form of currency, bond and other kind of

securities.Foreign exchange reserves are the foreign currency deposits held by national banks of

different nations. These are assets of Governments which are held in different hard currencies

such as Dollar, Sterling, Euro, Yen, Gold, SDRs.

The Economic Survey recently said India has the fourth largest foreign exchange

reserves, which helped the nation to tide over global financial crisis.India's foreign exchange

reserves touched $ 297.3 bn in December, 2010 from $ 279.1 bn in March. "It needs to be

acknowledged that foreign exchange reserves have helped insulate India from the worst impact

of the crisis," it said.

Unlike many Western nations, India was relatively less affected by the global financial

meltdown in 2008-09 that had pushed many advanced economies into recession. India had the

fourth largest foreign exchange reserves at $ 297.3 bn at the end of December 2010, it said.

At the same time, the foreign exchange reserves of Japan and Russia stood at $ 1.12

trillion and $ 479.4 billion, respectively. Neighbouring China's foreign exchange reserves was at

$ 2.45 trillion in June, 2010.According to the Survey, the country's reserves mainly comprise

portfolio investment (FII), "which are more vulnerable to sudden stops and reversals and

borrowings from abroad".

India's foreign exchange reserves have increased over the years from just $ 5.8 billion in

March, 1991. "The reserves reached a peak at $ 314.6 billion at May-end, 2008 before declining

to $ 252 billion at the end of March 2009."The decline in reserves in 2008-09 was inter alia a fall



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out of the global crisis and strengthening of US dollar vis-a-vis other international currencies,"

the Survey said.

About the idea of having a multilateral option of a pre-arranged credit line, the Survey

noted such an option is necessary but is not sufficient. "... (This is because) foreign investors

often view the size of foreign exchange reserves as a key input in taking investment decisions."

Movement of Reserves

Review of Growth of Reserves since 1991

Indias foreign exchange reserves have grown significantly since 1991. The reserves,

which stood at US$ 5.8 billion at end-March 1991 increased gradually to US$ 54.1 billion byend-March 2002, after which it rose steadily reaching a level of US$ 309.7 billion in March

2008. The reserves declined to US$ 252.0 billion in March 2009. The reserves stood at US$

292.9 billion as on September 30, 2010 compared to US $ 279.1billion as on March 31, 2010.

(Table 1 & Chart 1).

Although both US dollar and Euro are intervention currencies and the FCA are

maintained in major currencies like US dollar, Euro, Pound Sterling, Japanese Yen etc. the

foreign exchange reserves are denominated and expressed in US dollar only. Movements in the

FCA occur mainly on account of purchases and sales of foreign exchange by the RBI in the

foreign exchange market in India. In addition, income arising out of the deployment of the

foreign exchange reserves and the external aid receipts of the Central Government also flow into

the reserves. The movement of the US dollar against other currencies in which FCA are held

also impact the level of reserves in US dollar terms

Table 1 : Movement in Foreign Exchange Reserves

(US$ million)

Date FCA SDR Gold RTP Forex Reserves

30-Sep-

07239,954 2 (1) 7,367 438 247,761



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31-Mar-

08299,230 18 (11) 10,039 436 309,723

30-Sep-

08277,300 4 (2) 8,565 467 286,336

31-Mar-

09241,426 1 (1) 9,577 981 251,985

30-Sep-

09264,373 5224 (3297) 10,316 1365 281,278

31-Mar-

10254,685 5006 (3297) 17,986 1380 279,057

30-Sep-

10 265,231 5130 (3297) 20,516 1993

292,870

Notes: 1. FCA (Foreign Currency Assets): FCAs are maintained as a multi-currency

portfolio comprising major currencies, such as, US dollar, Euro, Pound sterling, Japanese

yen, etc. and are valued in terms of US dollars.

2. FCA excludes US$ 250.0 million invested in foreign currency denominated bonds

issued by IIFC (UK) since March 20, 2009.

3. SDR (Special Drawing Rights): Values in SDR have been indicated in parentheses.

They include SDRs 3082.5 million (equivalent to US $ 4883 million) allocated under

general allocation and SDRs 214.6 million (equivalent to US$ 340 million) allocated under

special allocation by the IMF on August 28, 2009 and September 9, 2009, respectively.

4. Gold: Gold includes US$ 6699 million reflecting the purchase of 200 metric tonnes of

gold from IMF during October 19-30 2009. The physical stock of gold which was 357.75

tonne as at end September 2009, increased to 557.75 tonne as at end September, 2010.5.

RTP refers to the Reserve Tranche Position in the IMF.



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Sources of Accretion to the Reserves

Table 2 provides details of the major sources of accretion to foreign exchange reserves during

the period from March 1991 to end-September 2010.

Table 2: Sources of Accretion to Foreign Exchange Reserves since

1991

(US$ billion)

Items 1991-92 to 2010-

11

(Upto September

2010)

A Reserves as at end-March 1991 5.8

B.I. Current Account Balance -144.7

B.II. Capital Account (net) (a to e) 415.7

a.Foreign Investment 236.2

Of which

FDI 102.7

FII 103.0



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b.NRI Deposits 39.1

c.External Assistance 24.3

d.External Commercial Borrowings 76.7

e.Other items in Capital Account* 39.0

B.III. Valuation Change 16.5

Reserves as at end-September 2010

(A+BI+BII+BIII)

292.9

* : Include errors and omissions.

External Liabilities vis--vis Foreign Exchange Reserves

The accretion of foreign exchange reserves needs to be seen in the light of total external

liabilities of the country. Indias International Investment Position (IIP), which is a summaryrecord of the stock of countrys external financial assets and liabilities as at end September 2010

is furnished inTable 4.The net IIP as at end September 2010 was negative at US$ 211.1 billion,

implying that our external liabilities are more than the external assets. The net IIP as at end

September 2008 and 2009 was US$ (-) 81.1 billion and US$ (-) 103.4 billion respectively.

Table 4: International Investment Position of India

(US$ billion)

Item September 2010 (P)

A Total External Assets 401.7

1. Direct Investment Abroad 89.2

2. Portfolio Investment 1.0

3. Other Investments 18.6

4. Foreign Exchange Reserves 292.9

B Total External Liabilities 612.8

1. Direct Investment in India 191.7

2. Portfolio Investment 164.3

3. Other Investments 256.8



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Net IIP (A-B) (-)211.1

P: Provisional.

Legal Framework and Policies

The Reserve Bank of India Act, 1934 provides the overarching legal framework for

deployment of reserves in different foreign currency assets (FCA) and gold within the broad

parameters of currencies, instruments, issuers and counterparties, the law broadly permits the

following investment categories:

(i) deposits with other central banks and the Bank for International Settlements (BIS);

(ii) deposits with foreign commercial banks;

(iii) debt instruments representing sovereign/sovereign-guaranteed liability with residual

maturity for the debt papers not exceeding 10 years;

(iv) other instruments / institutions as approved by the Central Board of the Reserve Bank in

accordance with the provisions of the Act; and

(v) dealing in certain types of derivatives

.RBI has framed appropriate guidelines stipulating stringent criteria for issuers / counterparties /

investments with a view to enhancing the safety and liquidity aspects of the reserves.

HISTORICAL OVERVIEW OF GOLD STANDARD AND BRETTON WOODS

SYSTEM

The gold standard:

This is the oldest system which was in operation till the bigining of first world war and

few years after that. In the version called Gold Specie Standard, the currency in circulation

consists of gold coins with a fixed gold content. In a version called Gold Bullion Standard, the



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basis of money remains a fixed weight of gold but the currency in circulation consists of paper

noteswith the monetory authorities i.e central bank of the country, standing ready to convert on

demand, unlimited amont of paper currency into gold and vice versa, at a fixed conversion ratio.

The exchange rate of any pair of currencies will be determined by their respective exchange rates

against gold. This is called mint-parity rate of exchange. The actual exchange rate can departfrom this mint-parity by a small margin on either side.

The Bretton Woods System

Fallowing the Second world war , policy makers from the victorious allied powers,

pricipally the US and the UK, took up the task of tharoughly revamping the world monetory

system for the non-communist world. The outcome of this is Bretton Woods System and the

birth of two institutions, the International Monetory Fund (IMF) and the World Bank. The

exchange rate regime that was put in place can be charectarised as the Global Exchange

Standard. It had the fallowing features:

The US government undertook to convert the US $ freely into gold at a fixed parity of

$35 per ounce.

Other member countries of IMF agreed to fix the parities of their currencies vis--vis the

dollar with variation within 1% on either side of the central parity being permissible. If

the exchange rate hit either of the limits, the monetary authorities of the country were

obliged to defend it is by standing ready to buy or sell dollar against their domestic

currency to any extent requaired to keep the exchange rate within the limits.

In return for undertaking this obligation, the member countries were entitled to have access to

credit facilities from the IMF to carry out their intervention in the currency market.

Why do country need International trade?

There are numerous reasons that countries engage in international trade. A variety of



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theories or explanations of international trade have been proposed. The most appealing

explanation contained in the doctrine of comparative advantage attributed to economist David

Ricardo. To understand this theory, let us consider a simple example. In a town there are two

persons Mr. X and Mr. Y. Mr. X is an excellent carpenter as well as good plumber. Where as

Mr. Y is a fairly competent plumber and also possesses some carpenter skills. Can someexchange be mutually beneficial? It looks unlikely that Mr. X can benefit from the exchange

since he is good in both the aspects. It turns out this is not correct. Both of them will get benefit,

if Mr. X specializes in carpentry and Mr. Y in plumbing and each import the others output i.e.

Mr. X should import plumbing service from Mr. Y and Mr. Y should import carpentry service

from Mr. X. The key lays in the fact that Mr. X s margin of superiority over Mr. Y is much

greater in the carpentry than in plumbing. Mr. X has a competitive advantage in carpentry and

Mr. Y in plumbing though Mr. X has an absolute advantage in both.

The same logic as above lays behind in the trade between two countries. Some countries

are deficient in critical raw materials, such as lumber or oil. To make up for these various

deficiencies, countries must engage in international trade to obtain the resources necessary to

produce the goods and/or services desired by their citizens.

Adequacy of Reserves

Adequacy of reserves has emerged as an important parameter in gauging the countrys

ability to absorb external shocks. With the changing profile of capital flows, the traditional

approach of assessing reserve adequacy in terms of import cover has been broadened to include

a number of parameters which take into account the size, composition and risk profiles of

various types of capital flows as well as the types of external shocks to which the economy is

vulnerable.



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CHAPTER 2

RESEARCH DESIGN

TITLE OF THE STUDY :

Impact of the FOREX reserve on economic indicators GDP, Inflation and

balance of payment.

INTRODUCTION TO THE STUDY:

FOREX reserve are liquid holding of international assets. FOREX reserve

include overseas banknotes and risk-free government debt. FOREX reserve may be spent

to buy international technology goods and services.

Large reserve of foreign currency allows the government to manipulate

exchange rates usually to stabilize the foreign exchange rates to provide more favorable



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environment. The FOREX reserve also act as a hedging tool, which helps to reduce the

shocks to the economy.

Sajikumar (2005) in his research paper on determining the optimum level of foreign

exchange reserve mentioned-- the increase in the inflows of the foreign reserves in the

country by the route of ADRs, GDRs, FDIs, ECBs, portfolio investments, non-resident

deposits and bank capital raises the question of an optimum level of reserves. Further,

he discusses about the reserve adequacy indicators: Trade related indicators (reserves

should be equivalent to a few months of imports), Debt related indicators (reserves can

meet the external repayment obligations without additional borrowing for one year-

Guidotti rule) and money-related indicators i.e. reserves to broad money/ reserves to

reserve money.

Charan singh (September 2005) in his research paper on Should India Use Foreign

Exchange Reserves For Financing Infrastructure? at Stanford Center for International

Development mentioned -- the primary objectives of maintaining forex reserves is safety

and liquidity, maximizing returns is secondary. The forex reserves in India are managed

by RBI in consultation with the Government of India. The opinion of the author is that

India should not invest forex reserves in Infrastructure. Going ahead he says,

infrastructure projects in India yield low or negative returns due to difficulties: political

and economic especially in adjusting the tariff structure, introducing labor reforms, and

upgrading technology and the use of FER to finance infrastructure may lead to more

economic difficulties, including problems in monetary management.

A review of the literature on the topic reveals the determination of optimal level of

FOREX reserve was emphasized, the FOREX reserve investment on infrastructure and F

OREX reserve management. This research project intends to fill the research gap.

STATEMENT OF PROBLEM:Foreign reserve is one of the most important factors influencing the growth of the

economy. It helps the country to meet the requirement of foreign receipts and payments. It

varies with the flow of FII and FDIs to the country. It has an effective impact on

economic indicator of the economy, which act measuring tool of the economy. This study



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is to determine the impact of foreign exchange reserve on economic indicators like GDP,

Inflation, balance of payment (BOP), Interest rate.

OBJECTIVE OF THE STUDY:

The main objective of the study is to know how the economy isaffected by the FOREX reserve.

To know the criterions which influence the foreign investments.

To know how it can help in the development of the country.

Economic stability and growth with respect to FOREX reserve

SCOPE OF THE STUDY;The study helps to know how the FOREX reserve can helps to channelize the Balance of

Payment, how it helps to increase the GDP and also its effect on inflation.

RESEARCH DESIGN:The data will be used for this study is secondary data. Statistics information will be use

for interpretation and finding.

Analytical Tools such as Trend analysis and Moving average either of them will

be used.

LIMITATION OF THE STUDY:-The study is confined to the GDP, Inflation, and BOP connected with the Indian

economy.

-The FOREX reserve is also depend on the inflow of FIIs, FDIs, etc.

-The value of Reserve also depends on government policies.

CHAPTER SCHEME:

Chapter -1- Introduction to the study:

This chapter includes Concept of foreign exchange reserve and itsimpact on economic

indicators like GDP, Inflation, Balance of payment (BOP)



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Chapter 2- Research Design:

This chapter provide a plan of the study which includes Statement of problem, Need of the

study, Review of previous studies, Objectives of the study, Scope of the study,

Operational definition of concepts, Methodology, Limitations of the study.

Chapter 3- Industry Profile:

FOREX reserves.

Chapter 4- Analysis & Interpretation of Data

In this chapter the data collected from various sources has been analyzed interpreted and

tabulated. Appropriate graphs and diagrams will be used.

Chapter 5- Summary of findings, Conclusions & Recommendations:

This chapter provides an overview of the dissertation, summaries the findings under each

objective and provides conclusions and recommendations based on the findings.

BIBLIOGRAPHY: -

-International financial Management, fourth edition, P G APTE, The McGraw-Hill

companies.

-Finance journels

-Newspaper and magazine

Website :

- http://indiabudget.nic.in

-http://www.business-standard.com

http://indiabudget.nic.in/http://indiabudget.nic.in/


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CHAPTER 3

INDUSTRY PROFILE

BRIEF HERITAGE

The Forex, FX or currency industry could be the foreign exchange current market. The Forex in

its present form originates from 1973. On the other hand, its got been around, in some type or

one more, because the time from the Pharaohs. This is a sector exchange for altering dollars



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from a single form or currency to a further. If you want to journey from a person nation to one

additional, you would need to exchange money, and this can be what the foreign exchange

market does, it trades currencies.

In 1973 the Forex industry was began because the Bretton Woods Accord was ended. The

Bretton Woods process was started out immediately after the second World War, it consisted of

a set of guidelines and procedures to regulate the global monetary procedure, and it tied all its

member countries currencies to the US currency and this previous a single to gold. In 1971 the

US ended the convertibility of your dollar to gold. As countries began to leave the Gold Normal,

their currencies would turned out to be at no cost floating and therefore the currency marketplace

was born as a result. Totally free floating currencies signifies the rate of exchange would

fluctuate, moving both up or down depending on many unique factors CURRENCIES And also

the FOREX

The Forex marketplace has evolved into a huge about $3.00 Trillion dollar a day market. The

majority of your transactions, a whopping estimated 85%, is finished in USD (Usa Dollar). After

that the currencies using the most trading are, the EUR (Euro), GBP (Terrific Britains Pound,

also regarded as Cable, Sterling or Pound), CHF (Swiss Franc), JPY (Japanese Yen), CAD

(Canadian Dollar), AUD (Australian Dollar) and NZD (New Zealand Dollar). These are all of

the major currencies.

The most active and rewarding pairing of currencies are EUR/USD and GBP/USD. The British

Pound would be the most active and fastest relocating currency. As a way to trade with the

Forex, you might like to get a small chunk in the marketplace, to be able to get that we have to

possess a shifting current market. This suggests the currency pair we determine to trade in has

for being a person which is active and liquid.

Whats LIQUIDITY?

Liquidity will mean offering to a captive audience for your price tag that you want. One example

is, once you were to promote ice to your Eskimos, it would not be a famous product because

they have so very much of it, so you would not get the very same selling price for it as in case

you were to sell ice towards the inhabitants of the Caribbean island, in which ice is really a

scarce commodity. From the very same way, there exists a large currency current market which

just concentrates on a few select currency pairs since they would be the most active currencies.



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When you go for to trade in a very much less implemented currency, you will probably acquire

not lots of men and women are looking for a trade hence making trading much less lucrative.

Essentially the most active pairs are the GBP/USD and EUR/USD. The foreign exchange

marketplace is definitely the largest and most liquid money industry from the entire world.

HOW DO CURRENCIES MOVE?

If you happen to live while in the United states of America, and want to go on vacation to

Wonderful Britain, you are going to ought to buy pounds with your dollars. This can be referred

to as a foreign exchange trade. If you find yourself getting a currency, you can be offering one

more. Exchanges often happen in pairs, you will be frequently exchanging two currencies. If

your exchange pair is GBP/USD: Any time you decide to buy pounds, you certainly will be

marketing dollars, and if you ever are selling pounds, you might be shopping for bucks. You just

demand to choose irrespective of whether youre promoting or acquiring, this is a function of thefree-floating currency.

Any time you want to trade inside Forex, you require only concentrate on one factor, irrespective

of whether the chart is heading up or down. If the chart, or currency, is heading up, the factor to

carry out is get. If the chart, or currency, is going down, the matter to perform is offer.

THE 24-HOUR Industry

The Forex industry is also unique in that this is a 24 hour current market. It is easy to trade the

Forex 24 hours a day if you so choose. The currency market place follows the sun throughout the

globe, the sessions flow as follows. If we take a look at all times as Eastern Normal Time, Tokyo

will open at seven pm EST and near at 4 am EST. London might be the next marketplace,

opening at 4 am EST and closing at 12 noon EST. London has the added distinction of currently

being the largest, oldest currency center inside globe. It accounts for about 36.7% of many of the

trades across the planet, which makes it one of the most imperative global center for foreign

exchange, New York could be second with around 17% and Tokyo third with about 6%. Some

other distinction in regards to the London current market is the time slot from 4 am EST till

ten:30 am EST is well-known to traders as currently being the most active time when lots of bigmoves are created in the industry. Just after London, would be the time for that New York

current market to open at 8 am EST until 5 pm EST. One additional good time for buying and



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selling is going to be at five pm EST till seven pm EST, considering that there will likely be

plenty of exercise within the industry at this time as well.

ROLLOVER

Rollover happens every last day at five pm EST. Brokers shut down their tradings from 4:58 pm

right up until five:05 pm. They do that so that you can rollover the open positions from a single

day towards the upcoming. From the Forex, the rates of interest are set day by day, so they

rollover will roll the curiosity from a person day and update it towards the up coming day.

FOREX INDUSTRY IN PERSPECTIVE FEB 2011

The month of February witnessed quite a few developments in the retail forex industry with the

advent of the mainstream firms entering the fold and existing retail firms beefing up their

operations. The competition in the retail forex industry is good because apart from changing the

competitive landscape, it offers more choice and variation to the benefit of traders.

Some of the major highlights included FXIT which acquired an additional 30% interest in Forex

New York city LLC bringing it to an almost 50% stake. The Company, through ForexNYC,

provides introductory training as well as advanced training for retail traders that use the web-

based trading platform for buying and selling currencies, precious metals and commodity

futures. Then we heard the news report that Charles Schwab is in the early stagesof introducing

forex to the array of financial products available to its customer base, followed by TD

Ameritrade offering a new mobile trading platform for iPad users. TD Ameritrade made a

stealthy entry into forex in 2009, though its purchase of ThinkorSwim.

What we see is a consolidation of the mainstream retail forex. It galvanized the major retail

brokers, in the form of two Initial Public Offerings (IPOs), capital infusions, and overhauling

their advertising. In 2010, the US Commodity Future Trading Commission (CFTC) moved to

bring retail forex out of the shadows and under its regulatory umbrella. New rules raised

registered capital requirements, lowered leverage ratios, and generally increased the amount of

http://www.theforexdigest.com/charles-schwab-eyes-online-forex-businesshttp://www.theforexdigest.com/charles-schwab-eyes-online-forex-businesshttp://www.theforexdigest.com/td-ameritrade-launches-new-mobile-trading-platform-for-ipad-usershttp://www.theforexdigest.com/td-ameritrade-launches-new-mobile-trading-platform-for-ipad-usershttp://www.theforexdigest.com/charles-schwab-eyes-online-forex-businesshttp://www.theforexdigest.com/td-ameritrade-launches-new-mobile-trading-platform-for-ipad-users


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scrutiny applied to brokers. This forced smaller players to merge, move overseas, or quit the

retail forex business.

The changes we see highly benefit the traders, as we heard that CitiFX introduced a new forex

pricing structure, major currency spreads to under 2 pips for its favored customers. TradeStation

Forex also announced plans to launch and offer exclusively the companys new forex brokerage

offering beginning later this quarter. MIG Bank also unvieled a revolutionary new fully

transparent dealing model. The prices we obtain from our liquidity providers are 100%

transparent and can be disclosed to our clients at anytime. Our advanced IT infrastructure and

price aggregator system allow us to constantly receive quotes from all of our liquidity providers,

instantaneously analyze them and identify the best price available to fill our client orders.

quoted the spokesman for MIG Bank.

While things got quite busy on the retail forex front, the binary options industry was not to beleft behind. We learnt that SpotOptions, one of the leading binary options white label service

provider had sold off its flagship brand TraderXP at an undiscolsed amount. SpotOptions core

business has always been the software it provides to binary options brokers. It will now focus on

the development of the B2B software. TraderXP has been in the market since 2009, so the exit is

quite quick.

No one really knows if this was a successful exit or not, but it does leave large enough room for

debate, if the growth in the online binary options is either too rapid or for the lack of innovation.

There are quite a few binary options brands available. Looking a bit deeper one cannot fail to

notice the striking similarities, even more so when the brands are white labeled by just one

company.

We see that the retail forex industry is probably at a mature stage where consolidation and

mergers are the right way to move ahead. Its little cousin, the binary options trading industry is

just starting out and perhaps its a bit too early to speculate. All said and done, one can only wait

and watch while we witness further consolidation. Online discount brokers may also establish

themselves as a major force, luring customers through the strength of their brands and theaccompanying guarantee of transparency, as well the ability to trade different types of securities

using a single, integrated platform. Spreads will continue to fall for the major currencies, and

http://www.theforexdigest.com/mig-bank-at-the-forefront-of-innovation-by-offering-a-revolutionary-new-fully-transparent-dealing-modelhttp://www.theforexdigest.com/mig-bank-at-the-forefront-of-innovation-by-offering-a-revolutionary-new-fully-transparent-dealing-modelhttp://www.theforexdigest.com/mig-bank-at-the-forefront-of-innovation-by-offering-a-revolutionary-new-fully-transparent-dealing-modelhttp://www.theforexdigest.com/mig-bank-at-the-forefront-of-innovation-by-offering-a-revolutionary-new-fully-transparent-dealing-model


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even for some of the exotics. In fact, it probably wont be long before retail forex becomes

completely commoditized, and it loses its novelty.

5 Prediction for the Forex Industry in 2010 and beyond

The forex industry evolved nicely in 2009. Looking towards 2010, and the new decade, here

are 5 predictions about the industry.

I wrote this post after reading Kathy Liens excellent article about the top 5 events of this

decade. Im looking at trends that already began recently, as well as trends that I believe that

well see in 2010 and in the following years.

1. Forex trading will become more mainstream: Most people think of forex only in the

context of buying hard currency when they go for a trip abroad. As the forex industry

continues to evolve, I believe that it will become more mainstream, getting more

attention in the media, and becoming an investment channel that the banks offer.

2. BRIC currencies to become more popular: The big nations of Brazil, Russia, India and

China arent very popular with forex traders. Chinas economy is the third in the world,

and will soon become second, but the currency doesnt float. The other countries arent

popular now. Not yet. I already wrote about the Brazilian Real. I believe that their

popularity will rise: more brokers will offer them, people :in forums will talk about them,

and their trade volume will rise.

3. Consolidation of forex brokers: Currently there are lots of forex brokers out there.

Some are market-makers, and others are ECN/STP. Most traders dont know the

differences. I think that many of the smaller brokers, and especially market-makers, will

disappear or merge into bigger brokers. Consolidation happens in any maturing industry,

and it will eventually happen in forex.

4. Education will become important: Following the previous point, the level of education

is rising among traders and this will be seen not only in choice of brokers but also in

trading. Forex education will impact trading styles, profits and people who supply

resources for teaching and coaching forex. Heres more about the growing role of

education.

http://www.fx360.com/commentary/kathy/2531/top-5-forex-events-of-the-decade.aspx?num=1261938810526http://www.forexcrunch.com/usdbrl-a-pair-to-notice-in-2010/http://blogs.fxstreet.com/francesc/2009/11/19/education-is-going-to-dramatically-change-the-brokers-landscape-says-forex-magnates-michael-greenberg/http://www.fx360.com/commentary/kathy/2531/top-5-forex-events-of-the-decade.aspx?num=1261938810526http://www.forexcrunch.com/usdbrl-a-pair-to-notice-in-2010/http://blogs.fxstreet.com/francesc/2009/11/19/education-is-going-to-dramatically-change-the-brokers-landscape-says-forex-magnates-michael-greenberg/


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5. Commodities will grow with forex: Oil and gold are already quite popular. As the

world recovers, more commodities will be in the limelight. Silver has gained traction due

its rise, and a food crisis will probably make wheat very popular. Commodities dont

have to compete with forex: more brokers will probably offer both together. Its

becoming more and more common.

CHAPTER - 4

ANALYSIS AND INTERPRETATION OF DATA

BALANCE OF PAYMENT

Balance of payments may be used as an indicator of economic and political stability. For

example, if a country has a consistently positive BOP, this could mean that there is significant

foreign investment within that country. It may also mean that the country does not export much

of its currency.

This is just another economic indicator of a country's relative value and, along with all other

indicators, should be used with caution. The BOP includes the trade balance, foreign investments

and investments by foreigners

Types of Accounts:

The balance of payments for any country is divided into two broad categories:

The Current Account: It reports the various trades in import and export plus

income derivedfrom tourism, profits earned overseas, and payments of interest

The capital account: It reports sum of bank deposits, private investments and debt

securities soldby a central bank or official government agencies.

The official reserve account

It is a subdivision o f the capita l account which conta ins foreigncurrency and securities

held by the government or the central bank, which is used to balance thepayments from year

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to year. It is known as the balancing item and can be considered a "plugfactor" for

summing the balance of payments accounts to zero.

O v e ra l l b a la n c e o f p a ym e n t = C u rr e n t A c c o u n t B a la n c e+ C a p it a l a c c ou n tba la nc e+ Of fi ci al Reserve Account

USES :

BOP data gives a comprehensive overview of the macro-economic and monetary

s ituation of nat ional economy and is very vital for monetary and f inancial

monitoring purposes for policydeliberations in both the domestic and international contexts.

The data provides objective basisfor assessing the macro-economic and monetary situation of an

economy. BoP analysis helps inmacro-economic review on the following aspects of an economy

- Income growth

- External orientation

- Relationships between trade in goods and services and direct investment flows

- International banking transactions

- Assets securitization and financial market developments

- External debt situation



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Study on prospects for direct investment. Direct investment income data which is available in

theBoP current account and the economy's stock of direct investment provides a methodology

for analyzing profitability of FDI.

Implications of BoP performance on exchange rate movements. Exchange rate movements are

of conce r n f o r t r ade r s and i nves t o rs a s t hey r e f l ec t t he compe t it i venes s o f

t he expor t s o f aneconomy , t he chang i ng cos t s a s we l l a s t he exchange r a t e

risk associated with externalinvestment.

Causes:

A situation where sufficient financing on affordable terms cannot be obtained to meet

international payme nt obl ig at ion s cause s prob lems wi th BOP. I f di f f icu l t ies

persist , i t may lead to a crisis . Domestic currency depreciates rapidly, makinginternational goods and capital expensive and the economy may reach a situation of a

stand still. It may spread to other countries that are tightly linked with the domestic economy.

Key factors are weak domestic financial systems; large and persistent fiscal deficits; high levels

of external and/or public debt; exchange rates fixed at inappropriate levels; natural disasters; or

armed conflicts or a sudden and strong increase in the price of key commodities such as food

and fuel. Some of these factors will reduce exports or/ and increase imports. Others may reduce

the foreign financing available. Also investors may lose confidence in a country's prospects

leading to massive sales of assets, the so called "capital flight." Crises get complicated by inter-

linkages between various sectors of the economy. An imbalance in even one of the sectors will

rapidly spread to other sectors and will lead to culminating in a widespread economic disruption.

Shrinking foreign trade

INDIAs trade deficit during the first nine months of fiscal 2009-10 on a balance of payments

(BoP) basis was lower at US$ 89.51 bn compared with US$ 98.44 bn during the same period in

fiscal 2008-09. The trade deficit on a BoP basis in Q3 (US$ 30.72 billion) was, however, less

than that in Q3 of 2008-09 (US$ 34.04 billion). This is revealed in e report (India's Balance of



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Payments Developments during the first quarter (October-December) of 2009-10) of the

countrys central banking authorityReserve Bank of India(RBI).

The key features of Indias BoP that emerged in Q3 of fiscal 2009-10 were:(i) Exports recorded

a growth of 13.2 per cent during Q3 of 2009-10 over the corresponding quarter of the previous

year, after consecutive declines in the last four quarters.(ii) Imports registered a growth of 2.6

per cent in Q3 of 2009-10 after recording consecutive declines in the last three quarters.(iii)

Private transfer receipts remained robust during Q3 of 2009-10.(iv) Despite low trade deficit, the

current account deficit was higher at US$ 12.0 billion during Q3 of 2009-10 mainly due to lower

invisibles surplus.(v) The current account deficit during April-December 2009 was higher at

US$ 30.3 billion as compared to US$ 27.5 billion during April-December 2008.(vi) Surplus in

capital account increased sharply to US$ 43.2 billion during April-December 2009 (US$ 5.8

billion during April-December 2008) mainly on account of large inflows under FDI, Portfolioinvestment, NRI deposits and commercial loans.(vii) As the surplus in capital account exceeded

the current account deficit, there was a net accretion to foreign exchange reserves of US$ 11.3

billion during April-December 2009 (as against a drawdown of US$ 20.4 billion during April-

December 2008).

Major Items of India's Balance of Payments

(US$ million)

(2007-08) (PR) (2008-09) (P)April-December

(2008-09) (PR)

April-December

(2009-10) (P)

http://www.rbi.org.in/http://www.rbi.org.in/http://www.rbi.org.in/http://www.rbi.org.in/


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Exports 166163 175184 150520 124473

Imports 257789 294587 248967 213988

Trade Balance -91626 -119403 -98446 -89515

Invisibles, net 74592 89587 70931 59185

Current Account

Balance-17034 -29817 -27516 -30330

Capital Account* 109198 9737 7136 41630

Change in

Reserves#

(+ indicates

increase;-indicates

decrease)

-92164 20080 20380 -11330

Including errors & omissions; # On BoP basis excluding valuation; P: Preliminary, PR: Partially

revised. R: revised

SOURCE: Reserve Bank of India Report

Invisibles

The decline in invisibles receipts, which started in the Q4 of 2008-09, continued during Q3 of

2009-10. Invisibles receipts registered a decline of 3.1 per cent during the quarter (as against

an increase of 5.4 per cent in Q3 of 2008-09) mainly on account of decline in business,

communication and financial services, and investment income receipts. Although, software

exports recorded a robust growth of 15.3 per cent, services exports as a whole witnessed

decline of 12.3 per cent during the quarter as against an increase of 11.8 per cent during the

corresponding quarter of 2008-09.



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Invisible receipts recorded a decline of 7.7 per cent during April-December 2009, as

compared with an increase of 22.2 per cent in the corresponding period of the previous year,

mainly due to the lower receipts under almost all components of services coupled with lower

investment income receipts.

Invisibles Payments

Invisibles payments recorded a growth of 12.9 per cent during Q3 of 2009-10, as compared

with a low growth of 2.4 per cent in Q3 of 2008-09, mainly led by increase in payments under

almost all components of services. Invisibles payments witnessed a positive growth of 3.7 per

cent in April-December 2009 (10.4 per cent in April-December 2008) mainly supported by

higher business, communication and financial services, and increase in payments under

investment income account.

Invisibles Balance

Size of invisibles surplus in Q3 of 2009-10 was, however, lower than Q3 of preceding year.

Therefore, despite low trade deficit, the current account deficit was higher at US$ 12.0 billion

in Q3 of 2009-10 (US$ 11.7 billion in Q3 of 2008-09). Net invisibles (invisibles receipts

minus invisibles payments) stood at US$ 59.2 billion during April-December 2009 as

compared with US$ 70.9 billion during April-December 2008. At this level, the invisibles

surplus financed 66.1 per cent of trade deficit during April-December 2009 as against 72.0

per cent during April-December 2008.

Current Account Deficit

Net invisibles (invisibles receipts minus invisibles payments) stood at US$ 59.2 billion during

April-December 2009 as compared with US$ 70.9 billion during April-December 2008. At

this level, the invisibles surplus financed 66.1 per cent of trade deficit during April-December

2009 as against 72.0 per cent during April-December 2008.

Net capital flows at US$ 43.2 billion in April-December 2009 was much higher as compared

with US$ 5.8 billion in April-December 2008 mainly due to larger inflows under FDI,

portfolio investments and NRI deposits Due to lower outward FDI, the net FDI (inward FDI

minus outward FDI) was higher at US$ 16.5 billion in April-December 2009 as compared

with US$ 14.3 billion in April-December 2008.



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Portfolio investment witnessed large net inflows of US$ 23.6 billion during April-December

2009 as against a net outflow of US$ 11.3 billion in April-December 2008 due to large net FII

inflows of US$ 20.5 billion.

Net external commercial borrowings (ECBs) inflow slowed down to US$ 2.3 billion in April-

December 2009 (US$ 6.9 billion in April-December 2008) mainly due to increased

repayments.

The increase in foreign exchange reserves on BoP basis (i.e., excluding valuation) was US$

11.3 billion in April-December 2009 (as against a sharp decline in reserves of US$ 20.4

billion in April-December 2008). [A Press Release on the Sources of Variation in Foreign

Exchange Reserves is separately issued].

The gross disbursements of short-term trade credit was US$ 10.1 billion during Q1 of 2009-

10 almost same in Q1 of 2008-09. The repayments of short-term trade credits, however, were

very high at US$ 13.2 billion in Q1 of 2009-10 (US$ 7.8 billion in Q1 of 2008-09). As a

result, there were net outflows of US$ 3.1 billion under short-term trade credit during Q1 of

2009-10 (inflows of US$ 2.4 billion in Q1 of 2008-09)

Banking capital mainly consists of foreign assets and liabilities of commercial banks. NRI

deposits constitute major part of the foreign liabilities. Banking capital (net), including NRI

deposits, were negative at US$ 3.4 billion during Q1 of 2009-10 as against a positive net

inflow of US$ 2.7 billion during Q1 of 2008-09. Among the components of banking capital,

NRI deposits witnessed higher inflows of US$ 1.8 billion in Q1 of 2009-10 (net inflows of

US$ 0.8 billion in Q1 of 2008-09) reflecting the positive impact of the revisions in the ceiling

interest rate on NRI deposits.

Other capital includes leads and lags in exports, funds held abroad, advances received

pending for issue of shares under FDI and other capital not included elsewhere (n.i.e.). Other

capital recorded net outflows of US$ 1.6 billion in Q1 of 2009-10.

Balance of Payments (BoP)

Merchandise Trade

Exports



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On a BoP basis, Indias merchandise exports posted a decline of 17.3 per cent in

April-December 2009 (as against a high growth of 27.5 per cent in the

corresponding period of the previous year).

INDIA's cumulative value of exports for the first 11 months of fiscal 2009-10 (April-2009

to February-2010) stood at US $ 152983 million (Rs 727345 crore) as against US $ 172379

million (Rs. 774585 crore) registering a negative growth of 11.3 per cent in Dollar terms

and 6.1 per cent in Rupee terms over the same period last year. Country's cumulative value

of imports for the period April, 2009- February, 2010 was US $ 248401 million (Rs.

1180124 crore) as against US $ 287099 million (Rs. 1289412 crore) registering a negative

growth of 13.5 per cent in Dollar terms and 8.5 per cent in Rupee terms over the same

period last year.

Oil imports during this 11-month period were valued at US$ 73230 million which was 18.2

per cent lower than the oil imports of US $ 89492 million in the corresponding period last

year. Non-oil imports during April, 2009- February, 2010 were valued at US$ 175171

million which was 11.4 per cent lower than the level of such imports valued at US$ 197607

million in April 2008- February, 2009.

EXPORTS & IMPORTS (April-February, FY 2009-10)

In $ Million In Rs Crore

Exports including re-exports

2008-09 172379 774585

2009-10 152983 727345

Growth 2009-10/2008-

2009 (percent)-11.3 -6.1

Imports



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On a BoP basis, the merchandise trade deficit decreased to US$ 89.5 billion during April-

December 2009 from US$ 98.4 billion in April-December 2008 mainly on account of both

lower oil and non-oil import payments

Inflows & Outflows from NRI Deposits and Local Withdrawal (In $ millions)

Inflows Outflows Local Withdrawals

2006-07 (R) 19914 15593 13208

2007-08 (PR) 29401 29222 18919

2008-09 (P) 37,089 32,799 20,617

2008-09 (Q1) (PR) 9063 8249 5157

2009-10 (Q1) (P) 11172 9354 5568

P: Preliminary, PR: Partially revised. R: revised

SOURCE: Reserve Bank of India report India's Balance of Payments Developments

during the First Quarter (April-June 2009) of 2009-10

Variation in Reserves

During April-December 2009, there was an accretion to foreign exchange reserves mainly on

account of valuation gains. Also, inflows under foreign investments, Non-Resident Indian

deposits and short-term trade credits have contributed significantly to the increase in foreign

exchange reserves during April-December 2009.

On balance of payments basis (i.e., excluding valuation effects), the foreign exchange

reserves increased by US$ 11,300 million during April-December 2009 as against a decline of

US$ 20,380 million during April-December 2008. The valuation gains, reflecting the

depreciation of the US dollar against the major currencies, accounted for US$ 20,185 million

during April-December 2009 as compared with a valuation loss of US$ 33,375 million during



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April-December 2008. Accordingly, valuation gains during April-December 2009 accounted

for 64.1 per cent of the total increase in foreign exchange reserves.

GDP

Gross domestic product (GDP), is the measure of the value of the goods and services

produced by the U.S. economy within a given time period. GDP is one of the most

comprehensive and closely watched economic statistics. This is because several government

institutions make key decisions concerning the economy using it. Components of GDP by

expenditure GDP (Y) is a sum of Consumption (C), Investment (I), Government Spending (G)

and Net Exports (X -

M).

Y = C + I + G + (X M) Here is a description of each GDP component:



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C (consumption) is normally the largest GDP component in the economy, consisting of private

(household final consumption expenditure) in the economy. These personal expenditures fall

under one of the following categories: durable goods, non-durable goods, and services.

Examples include food, rent, jewelry, gasoline, and medical expenses but do not include the

purchase of new housing.

I (investment) include business investment in equipments for example and do not include

exchanges of existing assets. Spending by households (not government) on new houses is also

included in Investment. In contrast to its colloquial meaning, 'Investment' in GDP does not mean

purchases of financial products. Buying financial products is classed as 'saving', as opposed to

investment. This avoids double-counting: if one buys shares in a company, and the company

uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP

when the company spends the money on those things; to also count it when one gives it to thecompany would be to count two times an amount that only corresponds to one group of

products. Buying bonds or stocks is a swapping of deeds, a transfer of claims on future

production, not directly an expenditure on products.

G (government spending) is the sum of government expenditures on final goods and services.

It includes salaries of public servants, purchase of weapons for the military, and any investment

expenditure by a government. It does not include any transfer payments, such as social security

or unemployment benefits.

X (exports) represents gross exports.

M (imports) represents gross imports.

The White House and Congress uses the GDP statistics to prepare the Federal budget, the

Federal Reserve formulates monetary policy basing on the same. Wall Street and the business

community also depend on the GDP to prepare forecasts of economic performance that provide

the basis for production, investment, and employment planning.

Due to the procyclic nature of the GDP as an indicator, it is the most obvious statistic

to look up to when judging the present status of an economy any where in the world. This



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statistic is also used to determine the poverty index of an area and will thus influence in a

great way the governments investment strategies towards improving the area.

How is it compiled?

The government collects all information regarding investments and incomes earned byindividuals as well as companies from the national income and product accounts (NIPAs)

produced by the Bureau of Economic Analysis (BEA). The NIPAs are a set of economic

accounts that provide information on the value and composition of output produced in the

United States during a particular period and on the distribution and uses of the income

generated by the same production.

GDP is composed of goods and services that are produced for sale in the market. It is

however worth noting that there are goods that are produced but do not really go into the

market directly. These include services such as the defense services provided by the Federal

Government. Education services provided by local governments and other emergency housing

or health care services provided by nonprofit making organizations such as the Red Cross also

fall in the group of non-market productions, Homes or business structures that are owned and

occupied by the same persons all have to be taken into consideration when computing these

statistics. However, not all productive activity is included in GDP. Some activities, such as

the care of one's own children, unpaid voluntary work and illegal or black-market deals are

not included because they are difficult to evaluate, as no real documentation is available

following such transactions.

GDPs impact on Forex

GDP simply portrays the way money is earned and spent on a regular basis, it is therefore

has a very direct relationship to the foreign exchange rate. When the production is high and it

translates into good revenue the currency grows stronger. There are however other factors that

may lead to negative trends in the forex market. Take the situation of GDP getting high due to

some factors such as illegal dealings such as money laundering or criminal activity such as huge

ransoms in the case of piracy in the high seas. The effects would lead to inflation and the dollar



37/74

may loose its purchasing power, as there would be too much money circulating that has not

actually been earned. This would reduce the demand for the dollar and the forex rates would

have to come down. If the inflation persists, the federal bank may be compelled to adjust interest

rates in order to contain the situation. Such a move automatically affects the forex rates.

There is a likely chance that a high GDP may attract foreign products into the countryfrom other countries. If many countries target the U.S. as their export destination, it is likely that

the country may surfer a balance deficit due to too many imports at the expense of local exports.

The country may find itself importing more than their exports can match, a situation that may

reduce the dollar rate internationally.

The simple thing that is portrayed by GDP is the way money is earned and spent on a

regular basis, that is why it has a very direct relationship to the foreign exchange rate. The

currency grows stronger when the production is high and it translates into good revenue.

However there are other factors that may lead to negative trends in the forex market.

You may take the situation of GDP getting high. This might happen due to some factors

like illegal dealings such as money laundering or criminal activity or due to huge ransoms in the

case of piracy in the high seas. All such effects lead to inflation and the dollar's purchasing

power is decreased, as due to these illegal dealings too much money would be circulating that

has not actually been earned.

This in turn would reduce the demand for the dollar and eventually the forex

rates would come down. If the inflation persists, the federal bank might be forced to adjust

interest rates in order to regulate the situation. Automatically such a move will affect the forex

rates.

Forex reserve hoarding costs 2% of GDP

With around $312 billion foreign exchange (forex) reserves, Indias bank balance is quite

healthy. But the country seems to be paying a heavy price while accumulating excess foreign

exchange reserves or whats called reserve hoarding.



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A study by Abhijit Sen Gupta for economic think tank Indian Council of Research in

International Economic Relations (ICRIER) says the country is losing more than 2 per cent of its

gross domestic product (GDP) by accumulating reserves instead of employing resources to

increase the physical capital of the economy. By diverting resources from physical investment

and employing them for reserve accumulation, India lost nearly $13 billion, or 2.34 per cent, ofits GDP in 2003-04.

In the following two years the loss was slightly lower due to a higher return on foreign currency

assets. However, with a relatively low incremental capital-output ratio (ICOR) and hence a high

marginal product of capital in 2006-07, the loss rose drastically to nearly $18 billion, or 2.16per

cent, of GDP. Thus, we find that in terms of physical investment foregone, India is paying a

substantial cost, the study said.

The cost of excess reserves has been increasing steadily and in 2006-07 stood in excess of $2.5billion, or 0.30 per cent, of the GDP. The study makes three interesting observations: India has

accumulated excess reserves, the cost of excess reserves and how returns can be maximised.

By 2007 India had accumulated more than $80 billion of excess reserves, says the study

Cost of holding excess reserves: The Indian experience. The cost of holding reserves is

measured by the interest rate spread between the private sectors cost of short-term borrowing

abroad and the yield that

the central bank earns on its liquid assets.

The Reserve Bank of India (RBI) could well do to maintain an adequate level of reserves in the

form of low return but highly liquid assets for meeting its needs like current account financing,

meeting short term external debt obligations, restraining excessive volatility in the exchange rate

etc., and park the excess reserves in an account with an objective of maximising returns subject

to acceptable risks, Sen Guptas study points out.

The funds in such an account could be profitably invested in non-treasury based assets like

equities, private equity company and real estate, which are associated with greater market risk

and hence correspondingly higher returns.

The bulk of Indias reserves are held in the form of securities or deposits with foreign

commercial banks and international organisations. However, the rate of earning on foreign



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currency assets and gold, after accounting for depreciation was only 4.6 per cent in 2006-07 and

3.9 per cent in 2005-06. The inflation rate during these two years was around 5.43 per cent and

4.38 per cent, implying a real rate of return of -0.82 per cent in 2006-07 and -0.48 per cent in

2005-06.

The low returns are due to the RBIs cautious policies, which are guided by principles such as

maintaining mark-to-market value and liquidity by taking minimal credit and market risk. The

RBI limits itself to investing in short dated AAA-rated government debt securities. Such low

returns have raised several questions about the management of international reserves by the

RBI, the report said.

BIG MONEY, LOW RETURNS

RBI gets low returns on forex deployment in low-yielding securities abroad

Sen Gupta says forex should be deployed in high return areas like equity, real estate and private

equity companies

By diverting resources from physical investment and employing them for reserve

accumulation, India lost $18 bn in 2006-07

OVERVIEW

International trade uses a variety ofcurrencies, the most important of which are held as foreign

reserves by governments and central banks. Here the percentage of global cummulative reserves

http://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Foreign_reservehttp://en.wikipedia.org/wiki/Foreign_reservehttp://en.wikipedia.org/wiki/Governmenthttp://en.wikipedia.org/wiki/Central_bankhttp://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Foreign_reservehttp://en.wikipedia.org/wiki/Foreign_reservehttp://en.wikipedia.org/wiki/Governmenthttp://en.wikipedia.org/wiki/Central_bank


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held for each currency between 1995 and 2005 are shown: the US dollaris the most sought-after

currency, with theEuro in strong demand as well.

1. The economy of India is the fourth largest in the world, with a GDP of $3.63 trillion at PPP,

and is the tenth largest in the world with a $691.9 billion at 2004 USD exchange rates and has a

real GDP growth rate of 6.2% at PPP.

2. Growth in the Indian economy has steadily increased since 1979, averaging 5.7% per year in

the 23-year growth record.

3. Indian economy has posted an excellent average GDP growth of 6.8% since 1994 India, the

fastest growing free-market democracy in the world, registered a growth rate of 8.2 percent in

FY 2004.

4. India has emerged the global leader in software and business process outsourcing services,

raking in revenues of US$12.5 billion in the year that ended March 2004.

5. Agriculture has fall to a drop because of a bad monsoon in 2005. There is a paramount need to

bring more area under irrigation.

6. Export revenues from the sector are expected to grow from $8 billion in 2003 to $46 billion in

2007.

7. Indias foreign exchange reserves are over US$ 102 billion and exceed the forex reserves of

USA, France, Russia and Germany. This has strengthened the Rupee and boosted investor

confidence greatly.

8. A strong BOP position in recent years has resulted in a steady accumulation of foreign

exchange reserves. The level of foreign exchange reserves crossed the US $100 billion mark on

Dec 19, 2003 and was $142.13 billion on March 18, 2005.

9. Reserve money growth had doubled to 18.3% in 2003-04 from 9.2 in 2002-03, driven entirelyby the increase in the net foreign exchange assets of the RBI.

http://en.wikipedia.org/wiki/US_dollarhttp://en.wikipedia.org/wiki/Eurohttp://en.wikipedia.org/wiki/Eurohttp://en.wikipedia.org/wiki/US_dollarhttp://en.wikipedia.org/wiki/Euro


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EFFECT OF GDP ON FOREX MARKET

The simple thing that is portrayed by GDP is the way money is earned and spent on a regular

basis, that is why it has a very direct relationship to the foreign exchange rate. The currency

grows stronger when the production is high and it translates into good revenue. However there

are other factors that may lead to negative trends in the forex market.

You may take the situation of GDP getting high. This might happen due to some factors like

illegal dealings such as money laundering or criminal activity or due to huge ransoms in the case

of piracy in the high seas. All such effects lead to inflation and the dollar's purchasing power is

decreased, as due to these illegal dealings too much money would be circulating that has not

actually been earned.

This in turn would reduce the demand for the dollar and eventually the forex rates would come

down. If the inflation persists, the federal bank might be forced to adjust interest rates in order to

regulate the situation. Automatically such a move will affect the forex rates.



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INFLATION

inflation can be defined as the increase in the level of price. inflation could happen because too

many people are chasing too few goods (Demand pull) or the cost of production(raw materials,labor) went up (Cost push). When this happens, goods and services become more expensive and

not every body would be able to afford it. The govt try to reduce Price level by increasing

interest rates. An increase in interest rates would increase the value of investment for people who

have invested in the country. Potential investors would see the reward for investing in that

country thus demand more of their currency. this increases the demand and the value of the

currency.

When inflation rate is down, banks would cut down interest rates to encourage economic

activities. On the other hand, during high inflation, banks would increase the interest rates to

discourage lending and spending. Hiking up the interest rates boosts the value of the currency.

This is true in US where rising of interest rates by the Federal bank would encourage investors to

capitalize on higher returns.

Currencies also influence each other. For example the Bank of Japan has to pay close attention

to the market to make sure that their currency remains weak in order to maintain their high

export rates. This is due to Chinas reluctance to revalue the Chinese Yuan thus making Chinas

products more competitive. Meanwhile, the Euro is nick-named the anti-dollar, meaning that a

fall in the dollar value will boost up the Euro. This is due to the Euro becoming the up-and-

coming option for reserving currency as there is a possibility of the European economy

becoming much stronger and also the chances of the dollar depreciating are risky higher due to

long term deficits in trade balance. Plus, Japan holds a large percentage of their reserves in the

US dollar.

INFLATION is a term used to depict an increase of average prices through the economy. It

means that money is losing its power. In other words, when prices keep on rising because ofoverheated economic growth or lots of wealth in the marketplace chasing very less opportunities

is known as inflation. Usually salary increases so that organizations can hold on good



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employees. But unfortunately salary rises more slowly as compare to the prices of the

commodities. So at the end people life style actually decreases.

Impact of forex reserves, the silent killer

Another dimension to the entire issue is the issue of our burgeoning foreign exchange reserves.You may recall that India faced a huge forex crisis in the early 1990s, when it fell to less than

one billion dollars. Since then, India has seen an unprecedented accumulation of foreign

exchange. Forex reserves now stand in excess of $300 billion today.

This accumulation of forex reserves has its own impact on the inflation in India. And this

requires some explanation. To understand what has been stated above, one needs to look into the

composition of these reserves and distinguish between capital and revenue flows.

Unlike China, which has largely built its forex reserves by its gargantuan exports, India has

predominantly built its forex reserves through capital flows.

The following table captures the composition of India's forex reserves since 1991, when we

virtually had zero reserves:

* Total capital flows since 1991 = $360 billion

* Total revenue flows since 1991 = $60 billion

* Net forex reserves = $300 billion

It may be noted that India's imports have exceeded its exports in the aggregate by $60 billion

during this period. Indian policy-framers have to frame appropriate policies to attract capital

flows to compensate for the current account deficit. And unlike China, which attracts FDI flows,

India attracts FII flows, i.e. huge flows into the stock markets and remittances /deposits from

Non-Resident Indians.

According to reports, India had accumulated forex reserves of about $100 billion during 2007-08. This means a sustained inflow of approximately Rs 400,000 crore into the Indian economy

during this period. Naturally, this led to the classical case of too much money chasing too few

goods -- the classical definition of inflation.



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It may be recalled that the aggregate increase in the money supply (M3) in India was a mere 12

per cent in 2003 when this government took over. Now, thanks to the incessant capital flows, the

aggregate money supply within the economy now stands at 23 per cent -- far too high for

comfort

Inflation and Loss

Fiat currency, which identifies money that is not backed by gold, is always susceptible to

long-term devaluation, or inflation. Inflation identifies the loss of purchasing power that

occurs over time. Central banks pressure the value of domestic currency through printing

and creating money in order to buy foreign exchange.

Nations that hold large amounts of foreign currency incur losses in purchasing power as

the exchange values of that currency decrease. Foreign exchange reserves earn little in

terms of interest. This means that interest income will not overcome the losses realized

from holding depreciating currency. Treasury officials decide whether foreign exchange

reserves would have been of better service to the home nation as domestic investments

How will an increase in foreign exchange reserves help an economy?

Also, is it possible for an increase in foreign exchange reserves elevate the inflation?

An increase in foreign exchange reserves helps an economy by increasing the "cushion" it has

against excessive variations of the exchange rate. This is particularly important for fixed

exchange regimes where it is vital for an economy to keep its exchange rate constant, so the

greater the reserves the easier it it for this given economy to defend its parity because it can

conduct market operations (selling or buying foreign exchange) to maintain their parity.

It can also be important for floating regimes when the variations in the exchange rate are so great

that they can disrupt the international trade of this economy and, obviously, destabilize the

economy. Once again, the greater the reserves, the better off the central bank is to intervene the

foreign exchange market.

How can an increase in Foreign Exchange Reserves help cushion the effect of inflation to

citizens?



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We were assigned to analyze a news article and mine is about the Philippine government's

measures vs. inflation and selling its remaining Petron shares is one of their measures. It was

said that this will help increase Foreign Exchange Reserves. Now, I'm wondering how this can

help reducing the effects of inflation.

A central's bank sale of domestic currency to buy foreign assets in the foreign exchange market

results in an increase of the monetary base.

The increase in the money supply will lead to a higher real money supply in the short run which

will cause the interest rate on domestic currency assets to fall shifting the demand curve to the

left.

When the demand curve shifts to the left prices go down to reach a new lower equilibrium level.

CAUSES:

When the government of a country print money in excess, prices increase to keep up with

the increase in currency, leading to inflation.

Increase in production and labor costs, have a direct impact on the price of the final

product, resulting in inflation.

When countries borrow money, they have to cope with the interest burden. This interest

burden results in inflation.

High taxes on consumer products, can also lead to inflation.

Demands pull inflation, wherein the economy demands more goods and services thanwhat is produced.

Cost push inflation or supply shock inflation, wherein non-availability of a commodity

would lead to increase in prices.

PROBLEMS DUE TO INFLATION

When the balance between supply and demand goes out of control, consumers could

change their buying habits, forcing manufacturers to cut down production.

The mortgage crisis of 2007 in USA could best illustrate the ill effects of inflation.

Housing prices increases substantially from 2002 onwards, resulting in a dramatic

decrease in demand.



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Inflation can create major problems in the economy. Price increase can worsen the

poverty affecting low income household,

Inflation creates economic uncertainty and is a dampener to the investment climate

slowing growth and finally it reduce savings and thereby consumption.

The producers would not be able to control the cost of raw material and labor and hencethe price of the final product. This could result in less profit or in some extreme case no

profit, forcing them out of business.

Manufacturers would not have an incentive to invest in new equipment and new

technology.

Uncertainty would force people to withdraw money from the bank and convert it into

product with long lasting value like gold, artifacts.

How is forex reserve inflation appreciation of rupee related?

1. Imagine an X- shaped diagram in front of your eyes. Now place this within X and Y axis with

X axis being INR and Y axis being USD. Now imagine first arm of the X- diagram, the arm that

goes (\) ie topleft to bottom right: this is the Supply curve of USD vs INR. The other arm that

goes (/) ie topright to bottom left: this is the demand curve of USD vs INR. The point where both

the arms cross is the equilibrium point (E). This is the current exchange rate ie 1 USD =x INR.

2. Now, if Forex Reserve increases (inflates) the supply arm of the (X curve) shifts upward ie

more toward the Y-axis. The demand curve remains constant. Hence the point where the 2 arms

interesect, the equilibrium:E, have shifted. This new E, would mean less INR for more USD.

3. Hence the appreciation of INR

in effect, as the forex reserve increases (i), the supply of USD in the local Indian market (i),

hence there are fewer INR chasing the USD, whic

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