At
the first level, are tourists,
importers, exporters, investors, and so on. These are the immediate users and
suppliers of foreign currencies. At the second
level, are the commercial banks, which act as clearing houses between users
and earners of foreign exchange. At the third
level, are foreign exchange brokers through whom the nation’s commercial
banks even out their foreign exchange inflows and outflows among themselves.
Finally at the fourth and the
highest level is the nation’s central bank, which acts as the lender or buyer
of last resort when the nation’s total foreign exchange earnings and
expenditure are unequal. The central then either draws down its foreign
reserves or adds to them.
CUSTOMERS:
The
customers who are engaged in foreign trade participate in foreign exchange
markets by availing of the services of banks. Exporters require converting the
dollars into rupee and importers require converting rupee into the dollars as
they have to pay in dollars for the goods / services they have imported.
Similar types of services may be required for setting any international
obligation i.e., payment of technical know-how fees or repayment of foreign
debt, etc.
COMMERCIAL BANKS
They
are most active players in the forex market. Commercial banks dealing with
international transactions offer services for conversation of one currency into
another. These banks are specialised in international trade and other
transactions. They have wide network of branches. Generally, commercial banks
act as intermediary between exporter and importer who are situated in different
countries. Typically banks buy foreign exchange from exporters and sells
foreign exchange to the importers of the goods. Similarly, the banks for
executing the orders of other customers, who are engaged in international
transaction, not necessarily on the account of trade alone, buy and sell
foreign exchange. As every time the foreign exchange bought and sold may not be
equal banks are left with the overbought or oversold position. If a bank buys
more foreign exchange than what it sells, it is said to be in
‘overbought/plus/long position’. In case bank sells more foreign exchange than
what it buys, it is said to be in ‘oversold/minus/short position’. The bank,
with open position, in order to avoid risk on account of exchange rate
movement, covers its position in the market. If the bank is having oversold
position it will buy from the market and if it has overbought position it will
sell in the market. This action of bank may trigger a spate of buying and
selling of foreign exchange in the market. Commercial banks have following objectives
for being active in the foreign exchange market:
o
They
render better service by offering competitive rates to their customers engaged
in international trade.
o
They
are in a better position to manage risks arising out of exchange rate
fluctuations.
o
Foreign
exchange business is a profitable activity and thus such banks are in a
position to generate more profits for themselves.
o
They
can manage their integrated treasury in a more efficient manner.
CENTRAL BANKS
In most of the countries central bank
have been charged with the responsibility of maintaining the external value of
the domestic currency. If the country is following a fixed exchange rate
system, the central bank has to take necessary steps to maintain the parity,
i.e., the rate so fixed. Even under floating exchange rate system, the central
bank has to ensure orderliness in the movement of exchange rates. Generally
this is achieved by the intervention of the bank. Sometimes this becomes a
concerted effort of central banks of more than one country.
Apart
from this central banks deal in the foreign exchange market for the following
purposes:
o
Exchange rate management:
Though
sometimes this is achieved through intervention, yet where a central bank is
required to maintain external rate of domestic currency at a level or in a band
so fixed, they deal in the market to achieve the desired objective
o
Reserve management:
Central
bank of the country is mainly concerned with the investment of the countries
foreign exchange reserve in a stable proportions in range of currencies and in
a range of assets in each currency. These proportions are, inter alias,
influenced by the structure of official external assets/liabilities. For this
bank has involved certain amount of switching between currencies.
Central
banks are conservative in their approach and they do not deal in foreign
exchange markets for making profits. However, there have been some aggressive
central banks but market has punished them very badly for their adventurism. In
the recent past Malaysian Central bank, Bank Negara lost billions of dollars in
foreign exchange transactions.
o Intervention by Central Bank
It
is truly said that foreign exchange is as good as any other commodity. If a
country is following floating rate system and there are no controls on capital
transfers, then the exchange rate will be influenced by the economic law of
demand and supply. If supply of foreign exchange is more than demand during a
particular period then the foreign exchange will become cheaper. On the
contrary, if the supply is less than the demand during the particular period
then the foreign exchange will become costlier. The exporters of goods and
services mainly supply foreign exchange to the market. If there are no control
over foreign investors are also suppliers of foreign exchange.
During
a particular period if demand for foreign exchange increases than the supply,
it will raise the price of foreign exchange, in terms of domestic currency, to
an unrealistic level. This will no doubt make the imports costlier and thus
protect the domestic industry but this also gives boost to the exports.
However, in the short run it can disturb the equilibrium and orderliness of the
foreign exchange markets. The central
bank will then step forward to supply foreign exchange to meet the demand for
the same. This will smoothen the market. The central bank achieves this by
selling the foreign exchange and buying or absorbing domestic currency. Thus
demand for domestic currency which, coupled with supply of foreign exchange,
will maintain the price of foreign currency at desired level. This is called ‘intervention by central bank’.
If
a country, as a matter of policy, follows fixed exchange rate system, the
central bank is required to maintain exchange rate generally within a
well-defined narrow band. Whenever the value of the domestic currency
approaches upper or lower limit of such a band, the central bank intervenes to
counteract the forces of demand and supply through intervention.
In
India, the central bank of the country, the Reserve Bank of India, has been
enjoined upon to maintain the external value of rupee. Until March 1, 1993,
under section 40 of the Reserve Bank of India act, 1934, Reserve Bank was
obliged to buy from and sell to authorised persons i.e., AD’s foreign exchange.
However, since March 1, 1993, under Modified Liberalised Exchange Rate Management System (Modified LERMS),
Reserve Bank is not obliged to sell foreign exchange. Also, it will purchase
foreign exchange at market rates. Again, with a view to maintain external value
of rupee, Reserve Bank has given the right to intervene in the foreign exchange
markets.
EXCHANGE BROKERS
Forex brokers play a very important
role in the foreign exchange markets. However the extent to which services of
forex brokers are utilized depends on the tradition and practice prevailing at
a particular forex market centre. In India dealing is done in interbank market
through forex brokers. In India as per FEDAI guidelines the AD’s are free to
deal directly among themselves without going through brokers. The forex brokers
are not allowed to deal on their own account all over the world and also in
India.
o How Exchange Brokers Work?
Banks seeking to trade display their
bid and offer rates on their respective pages of Reuters screen, but these
prices are indicative only. On inquiry from brokers they quote firm prices on
telephone. In this way, the brokers can locate the most competitive buying and
selling prices, and these prices are immediately broadcast to a large number of
banks by means of hotlines/loudspeakers in the banks dealing room/contacts many
dealing banks through calling assistants employed by the broking firm. If any
bank wants to respond to these prices thus made available, the counter party
bank does this by clinching the deal. Brokers do not disclose counter party
bank’s name until the buying and selling banks have concluded the deal. Once
the deal is struck the broker exchange the names of the bank who has bought and
who has sold. The brokers charge commission for the services rendered.
In
India broker’s commission is fixed by FEDAI.
SPECULATORS
Speculators
play a very active role in the foreign exchange markets. In fact major chunk of
the foreign exchange dealings in forex markets in on account of speculators and
speculative activities.
The
speculators are the major players in the forex markets.
Banks
dealing are the major speculators in the forex markets with a view to make
profit on account of favourable movement in exchange rate, take position i.e.,
if they feel the rate of particular currency is likely to go up in short term.
They buy that currency and sell it as soon as they are able to make a quick
profit.
Corporations
particularly Multinational Corporations and Transnational Corporations having
business operations beyond their national frontiers and on account of their
cash flows. Being large and in multi-currencies get into foreign exchange
exposures. With a view to take advantage of foreign rate movement in their
favour they either delay covering exposures or does not cover until cash flow
materialize. Sometimes they take position so as to take advantage of the
exchange rate movement in their favour and for undertaking this activity, they
have state of the art dealing rooms. In India, some of the big corporate are as
the exchange control have been loosened, booking and cancelling forward
contracts, and a times the same borders on speculative activity.
Governments narrow or invest in foreign
securities and delay coverage of the exposure on account of such deals.
Individual like share dealings also
undertake the activity of buying and selling of foreign exchange for booking
short-term profits. They also buy foreign currency stocks, bonds and other
assets without covering the foreign exchange exposure risk. This also results
in speculations.
Corporate entities take positions in
commodities whose prices are expressed in foreign currency. This also adds to
speculative activity.
The speculators or traders in the forex
market cause significant swings in foreign exchange rates. These swings,
particular sudden swings, do not do any good either to the national or
international trade and can be detrimental not only to national economy but
global business also. However, to be far to the speculators, they provide the
much need liquidity and depth to foreign exchange markets. This is necessary to
keep bid-offer which spreads to the minimum. Similarly, liquidity also helps in
executing large or unique orders without causing any ripples in the foreign
exchange markets. One of the views held is that speculative activity provides
much needed efficiency to foreign exchange markets. Therefore we can say that
speculation is necessary evil in forex markets.
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