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Exchange rate management and control
Rohit Oberoi
MBA 4thsemWFTM
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Topics Covered
1. IMS(international monetary system)
2. types of exchange rates
3. FERA/FEMA
4. Determination of foreign exchange
rate-exchange control regulations andprocedures in india.
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The international monetary system refers tothe institutional arrangements that countries
adopt to govern exchange rates.
Also called International monetary and FinancialSystem.
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International monetary systems are sets of
internationally agreed rules, conventions and
supporting institutions that facilitate
international trade, cross border investment
and generally the reallocation of capital
between nation states
Objective of IMSTo contribute to stable and high global growth
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Evolution of the
International Monetary System
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Bimetallism: Before 1875
A double standard in the sense that both gold
and silver were used as money.
Both gold and silver were used as international
means of payment and the exchange ratesamong currencies were determined by eithertheir gold or silver contents.
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Bimetallism: Before 1875
Great Britain: Until 1816 (law passed for free coinage on gold only)
US: From 1792 (Coinage Act of 1792) till 1873
France: Since French Revolution till 1878
India, China, Germany, Holland were on silver standard
Due to wars and political unstability, US, Russia and Austria-Hungry had irredeemablecurrencies :1848-79
Not systematic IMS until 1870s
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Bimetallism: Before 1875
Greshams Law
Phenomenon experienced by the countriesthat were on the bimettalic standard.
Since exchange rate between two currency
was fixed officially, only the abundant metalwas used as money, driving more scarce metalout of circulation.
Greshams Law: Bad (abundant) moneydrives out Good(scarce) money
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Classical Gold Standard:
1875-1914
Strong interest of every
country to implement the
same international
monetary system as their
most important economic
and financial partners have
implemented
Country Year
Great Britain 1816
Germany 1871
Sweden, Norway and Denmark 1873
France, Belgium, Switzerland, Italy and
Greece
1874
Netherlands 1875
Uruguay 1876
USA 1879
Austria 1892
Chile 1895
Japan 1897Russia 1898
Dominican Republic 1901
Panama 1904
Mexico 1905
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Classical Gold Standard:
1875-1914
During this period in most major countries:
Gold alone was assured of unrestricted coinage
There was two-way convertibility between gold and nationalcurrencies at a stable ratio.
Gold could be freely exported or imported.
The exchange rate between two countrys currencies
would be determined by their relative gold contents.
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For example, if the dollar is pegged to gold at
U.S.$30 = 1 ounce of gold, and the British
pound is pegged to gold at 6 = 1 ounce of gold,
it must be the case that the exchange rate is
determined by the relative gold contents:
Classical Gold Standard:
1875-1914
$30 = 6
$5 = 1
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Classical Gold Standard:
1875-1914
Highly stable exchange rates under the classical
gold standard provided an environment that
was favorable to international trade and
investment.
Misalignment of exchange rates and
international imbalances of payment were
automatically corrected by theprice-specie-flow
mechanism.
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Price-Specie-Flow Mechanism
Suppose Great Britain exported more to France than
France imported from Great Britain.
Net export of goods from Great Britain to France will be
accompanied by a net flow of gold from France to Great Britain. This flow of gold will lead to a lower price level in France and, at
the same time, a higher price level in Britain.
The resultant change in relative price levels will slow
exports from Great Britain and encourage exports fromFrance.
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Classical Gold Standard:
1875-1914
There are shortcomings:
The supply of newly minted gold is so restricted that
the growth of world trade and investment can be
hampered for the lack of sufficient monetary
reserves.
Even if the world returned to a gold standard, any
national government could abandon the standard.
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The Interwar Experience
With the outbreak of World War I, the classicalgold standard came to an end: exchange rate depended completely on the supply
of and demand for foreign currency
extremely negative effects of the lack ofagreement on the functioning of theinternational monetary system
three trials of establishment: Conference in Genoa (1922) negotiations in 1933 three-party agreement between the USA, Great
Britain and France (1936)
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1919 1926: Experience With
Flexible Exchange Rates entirely different economic and political
circumstances at the end of World War I
made quick return to stable economic
circumstances realistically impossible
flexible exchange rates were perceived as
an exclusively temporary solution that
needed to be replaced by a morepermanent solution (going back to the pre-
war classical gold standard) as soon as
possible
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1919 1926: Experience With
Flexible Exchange Rates
high rate of inflation caused by printing ofmoney, that was used for financing high
budget deficits an ingredient of stabilization programs was
establishment of the mint parity ofnational currencies, or return to gold
standard
countries with hyperinflation and their returnto the gold standard:
which mint parity should be used?
return of other countries to the gold standard:
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1926 1931: Functioning of the
Renewed Gold Standard Period
mint parity was established at the wrong
level, resulting in continued problems in
the balance-of-payments adjustments not a real gold standard, rather, a gold
exchange standard:
assumption of high confidence intocountries with a reserve currency to
guarantee unconditional conversion oftheir currencies into gold
differencesin gold
standard inthe interwarperiod and
beforeWorld War I:
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1926 1931: Functioning of the
Renewed Gold Standard Period not following the rules of the game or differentpriorities of national economic policies :
countries started to systematically give priority to
internal economic goals and relatively lowerimportance to balance-of-payments equilibrium
changed significance of the short-run capital
flows:
flows under the strong influence of lowered
confidence into mint parities, which was reflected
mostly in escape of capital from weak currencies
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1926 1931: Functioning of the
Renewed Gold Standard Period
End of the gold standard:
convergence of different causes that pressuredthe already weak international monetary
system of renewed gold standard at the end of
1920s
deflation and unemployment; New York StockExchange crisis (1929)
decreased confidence
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1931 1944: Period of Economic
Nationalism cannot talk about the existence of an
international monetary system
economic nationalism: competitive devaluations
protectionism
trade wars, international trade cut almost in half
less international provision of credit and investment
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