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Because of its scarcity, foreign exchange in India was long considered a strictly regulated and managed commodity. Controlling demand for foreign currency in the early phases of foreign exchange management in the country was based on the fact that there was a limited supply of it. The Defence of India Rules instituted temporary exchange controls in India on September 3, 1939.
The Reserve Bank was given the authority to control and regulate transactions involving foreign exchange payments outside India, the export and import of currency notes and bullion, the transfer of securities between residents and non-residents, acquisition of foreign securities, and acquisition of immovable property, among other transactions.
Liberalized Approach
To become an authorized dealer in the foreign currency market, a bank or other financial institution must be granted a licence by the Reserve Bank. The Reserve Bank has significantly reduced licencing, quantitative limits, and other regulatory and discretionary constraints due to the march toward liberalization.
In addition to removing limits on foreign exchange transactions in regards to processes and procedures, the Reserve Bank has offered the exchange facility for liberalized travel overseas for objectives such as doing business, attending international conferences, completing technical study tours, establishing joint ventures abroad, negotiating the foreign partnership, pursuing higher studies & training, and also for medical treatment. Reserve Bank has also allowed citizens to keep a large quantity of foreign currency in their bank accounts. Indian citizens can open foreign currency accounts and deposit specific foreign exchange receipts into them for the first time.
Investment from abroad
From a variety of sources, foreign investment enters India. The Reserve Bank has eased restrictions on these investments as part of its reforms. Foreign investment is approved in nearly all areas, with a few exclusions, by the Reserve Bank. Non-residents can invest in India without obtaining prior authorization from the Indian government or Reserve Bank. All equity securities traded on the primary and secondary markets are open to foreign institutional investors. The government of India has also granted permission for foreign institutional investors to invest in treasury bills and dated securities issued by the government, corporate debt instruments, and mutual funds. Non-resident Indians (NRIs) choose to reinvest or not reinvest their money.
Sophisticated Remittance Program
Foreign exchange facilities for residents have been further simplified and liberalized with the Reserve Bank allowing citizens to freely send money overseas up to a liberal amount each financial year for any approved uses.
Futures Contracts on Currencies
In India, currency futures can be traded on the open market. The National Stock Exchange, the Bombay Stock Exchange, and the MCX-Stock Exchange currently offer such services. The Reserve Bank of India and the Securities and Exchange Board of India jointly regulate currency futures trading because the product is exchange-traded.
Inflationary Policy
India’s monetary policy has changed in lockstep with global and domestic trends. Fixed exchange rates were in place during the post-independence period, following the Bretton Woods system. Due to historical ties with the United Kingdom, the Indian Rupee was fixed to the Pound Sterling. Most countries adopted a flexible/managed exchange rate system following the demise of the Bretton Woods System in the early seventies. After Britain’s share in India’s commerce fell, India’s international transactions became more diverse. The reliance on a single currency was exposed; the Indian Rupee was decoupled from the Pound Sterling.
After that, the exchange rate was set based on the daily fluctuations of an unnamed basket of currencies representing India’s most important trading partners. A lack of understanding of market dynamics and changes in other nations’ currency rates meant that market forces permitted the Rupee’s external value following the country’s balance-of-payment troubles in the early 1990s.
1991 saw a major depreciation of the Rupee, which was accomplished in two steps. Dual exchange rates were introduced in March 1992 as part of the Liberalized Exchange Rate Management System (LERMS). On March 1, 1993, the LERMS was replaced by a market-based exchange rate system based on demand and supply for foreign exchange.
Reserve Bank’s exchange rate policy is geared toward maintaining order in the foreign exchange market. It keeps a careful eye on the financial markets both domestically and internationally. As a last resort, the government will acquire or sell foreign currency. Trading might be done directly or through a public sector institution.
The Reserve Bank has helped increase the supply of derivative instruments in the foreign currency market and the standard forward and swap contracts. Foreign currency swaps, Rupee options, cross-currency options, interest rate swaps, currency swaps, forward rate agreements, and currency futures trading are all now possible through this platform.
Management of Foreign Exchange Reserves
The Reserve Bank of India safeguards its foreign exchange reserves and oversees its investment portfolio in India. The Reserve Bank of India Act, 1934 lays forth the rules for managing the country’s foreign exchange reserves.
First, the Reserve Bank’s holdings of foreign money have grown significantly. Second, the challenge of keeping the value of reserves and achieving a reasonable return on them has become more difficult due to the growing volatility in exchange and interest rates worldwide.
Foreign exchange reserve management at the Reserve Bank is guided by three main principles: safety, liquidity, and returns. India’s Reserve Bank of India Act allows the Reserve Bank of India to invest its reserves in the following instruments:
Deposits at the Bank for International Settlements (BIS) and other central banks
Deposits made in foreign commercial banks
Debt instruments reflect governmental or sovereign-guaranteed liabilities with a residual maturity of no more than 10 years.
According to the Act, the Central Board of the Reserve Bank may approve additional instruments and institutions.
There are some forms of derivatives.
Conclusion
To increase the safety and liquidity of reserves, the Reserve Bank has established policy guidelines that stipulate strict eligibility conditions for issuers, counterparties, and investments to be made with them. Together with the government, the Reserve Bank is constantly re-evaluating the country’s reserve management policies.
