Functions of Foreign Exchange Market

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Foreign Exchange is the process of conversion of one currency into another currency. For a country its currency becomes legal tender. For a foreign country it becomes the value as a commodity. Since the commodity has a value its relation with the other currency determines the exchange value of one currency with the other.

For example, the US dollar in USA is the currency in USA but for India it is just like a commodity, which has a value which varies according to demand and supply. Foreign exchange is that section of economic activity which deals with the methods in which rights to wealth expressed in terms of the currency of one country are converted into rights to wealth in terms of the current of another country. It involves the investigation of the method, which exchanges the currency of one country for that of another.

Foreign exchange can also be defined as the means of payment in which currencies are converted into each other and by which international transfers are also made. Most countries of the world have their own currencies The US has its dollar, France its franc, Brazil its cruziero; and India has its rupee. Trade between the countries involves the exchange of different currencies. The foreign exchange market is where currencies are bought & sold against each other. It is the largest market in the world transactions conducted in foreign exchange markets determine the rates at which currencies are exchanged for one another, which in turn determine the cost of purchasing foreign goods & financial assets. The most recent, bank of international settlement survey stated that over $900 billion were traded worldwide each day. During peak volume period, the figure can reach upward of US $2 trillion per day. The corresponding to 160 times the daily volume of NYSE.

Globally foreign exchange market started in a major way after the breakdown of the Bretton Woods system in 1971, which also marked the beginning of floating exchange rate regimes in several countries. After 1990s witnessed a perceptible policy shift in many emerging markets towards reorientation of their financial markets in terms of new products and instruments.

The changing forms were reflected in a rapid expansion of foreign exchange market in terms of transaction volumes drop in transaction costs and efficient mechanisms of risk transfer.

The beginning of the foreign exchange market in India started in year 1978 when banks in India were allowed to undertake intra-day trade in foreign exchange. But it was in the 1990s that the Indian foreign exchange market viewed changes with the shifts in the currency regime in India. The exchange rate of the rupee that was “pegged” earlier was changed to “float “partially in March 1992 and entirely in March. The combination of the exchange rate was helpful in developing a market determined exchange rate of the rupee and an important step in the progress towards current account convertibility, which was accomplished.

In August 1994 further development of the foreign exchange market in India was provided with the setting up of an Expert Group on Foreign Exchange Markets in India which submitted its report in June 1995. The Group made several recommendations for deepening and widening of the Indian foreign exchange market.

Hence from beginning from January 1996, wide-ranging reforms have been undertaken in the Indian foreign exchange market. After a decade, an Internal Technical Group on the Foreign Exchange Market (2005) was constituted to undertake a complete review of the measures initiated by the Reserve Bank and identify areas for further liberalization or relaxation of restrictions in a medium-term framework.

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