Concepts related to External Sector

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Round Tripping
  • Indian Person has black money, sent to
  • India Black Money → Switzerland → Dubai → Hong Kong → Singapore → Moriches → finally invested in India.
  • SEBI not able to find origin of Money to tax or curtail black money.
Derivative Investment – Derive its value form other assert.
Franchise Model
  • If I want to start the KFC Branch at Anna Nagar, Chennai. KFC give brand name, brand Secrets, Office culture & Maintenance but No investment. I use brand name and start company and give share to KFC.
Treaty Shopping
  • Company see all country treaty, which country treaty is suitable for then, invested in the Country.
Global Minimum Taxation
  • At G7 Meet of 2020, Bidan say Global Minimum taxation is 15%.
  • But some country says, Corporate tax of their country is 5%, 8% or even less. So, Bidan say Company pay 8% to home country & Balance 7% to country which they had the company.
  • Ex: South Korea company start company in India. South Korea (12% Tax) & India (15% Tax).
  • Company must pay 15% as Minimum tax. But South Korea has less then 15%. So,
    • Company pay 12% to South Korea & Balance 3% to India. or
    • Company pay Full tax on India (15%).
Foreign Exchange
  1. Foreign Exchange Rate (Ex: 1$ = Rs. 81)
  2. Nominal Exchange Rate (Without consider Inflation Value)
    • Appreciation (1$ = 75) – Rupee Strengthening
    • Depreciation (1$ = 85) – Rupee Weakening.
    • Revaluation (Never in India)
    • Devaluation (3 times,1947, 1$ = Rs.1, 1766, 1$ = 4 Rs to 7 Rs, 1991, devaluate by condition of IMF).
      • Last two used as Central Bank (RBI).
  3. Real Exchange Rate (Consider Inflation Value)
  4. Nominal Effective Exchange Rate
  5. Real Effective Exchange Rate
    • (Compare Indian Rupee to 6 Strong currency of world, take weighted average of currency and says strength of Indian Currency). Taking Inflation in account is REER, not taking inflation in account is NEER.
    • Also Compare Indian currency to 36 Country currency & Weightage.
  6. Currency Exchange System
    • Till WW-II, Exchange rate is fixed by the country (Gold flag system)
    • Fixed exchange rate system (After World war II – UN, Bretton wood System (World Bank, IMF developed)
    • Fixed but adjustable exchange rate system (Fixed for More time, if needed they can adjust).
    • Crawling peg exchange rate system (Set upper & Lower limit of Exchange rate, Ex: 1$=80 value, Upper limit 85, Lower limit 75).
    • Managed Float Exchange rate system (Exchange rate is determined by market, whenever needed it is Govt take action. Ex: India).
    • Free Float system (Never Interfere by Govt). – USA, UK – is near to Free Float System.
  7. Foreign Exchange Market
    • Exchange Function (Just exchange of Currency)
    • Credit Function (Give loan in Foreign currency)
    • Hedge Function (Fixed rate on loan repayment. TATA buy 1000 tyre in MRF on loan ($10000) of 6-month repayment loan. After six months the dollar value increase or decrease, TATA give only $10000 to MRF).
      • Spot (Pay at Spot)
      • forward (Fixed rate can pay in future)
        • Future (Not Possible to cancel the fixed rate)
        • Option (Possible to cancel the fixed rate, who cancel need to give Premium to Other)
(Agriculture, Iron & Steel, Stock, Gold etc... has used Hedge Function of Exchange)
Arbitrage Trading
  • 1$ = 80 Rs in India, but you can buy 1$ = 70 in Sri Lanka. So Traders buy dollars in Sri Lanka and Sell in India.
  • Because of More buy in Sri Lanka dollar value increase to 75 Rs, and More selling in India cause dollar value decrease attain 75.
  • Attain Equilibrium of Rs.75 in both countries.
Foreign Exchange Rate
  • Foreign Exchange Rate is defined as the price of the domestic currency with respect to another currency. The purpose of foreign exchange is to compare one currency with another for showing their relative values.
  • Foreign exchange rate can also be said to be the rate at which one currency is exchanged with another or it can be said as the price of one currency that is stated in terms of another currency.
  • Exchange rates of a currency can be either fixed or floating. Fixed exchange rate is determined by the central bank of the country while the floating rate is determined by the dynamics of market demand and supply.
  • The real exchange rate (RER) between two currencies is the nominal exchange rate (e) multiplied by the ratio of prices between the two countries, P/P*. (Inflation Adjusted)
  • Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) are indicators of external competitiveness.
  • The nominal effective exchange rate (NEER) is an unadjusted weighted average rate at which one country’s currency exchanges for a basket of multiple foreign currencies.
  • NEER is a weighted index that reflects the trade of India with other countries. The weight is greater for countries with which India trades more.
  • The NEER may be adjusted to compensate for the inflation rate of the home country relative to the inflation rate of its trading partners. The resulting figure is the real effective exchange rate (REER).
  • The new six-currency indices represent the US, the Eurozone (comprising of 12 countries), UK, Japan, China and Hong Kong SAR. Two currencies in the existing five-country series, viz., French franc and Deutsche mark have been replaced by the Euro in the new indices.
  • Two new currencies have been included in the new indices, both being Asian - the Chinese yuan and the Hong Kong Dollar.
  • The rapid growth in India’s foreign trade with China and Hong Kong in the recent years has been the underlying factor for including these two countries in the new six-currency REER.
  • Read NEER & REER of RBI – 6 Currency & 36 Currency Series - https://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=7129
Devaluation of a currency
  • Devaluation of a currency is associated with countries having a fixed exchange rate regime. Under the fixed rate regime, the central bank or the government decides the value of the currency with respect to other foreign currencies. The central bank or the government purchases or sells its currencies to maintain the exchange rate.
  • When the government or the central bank reduces the value of its currency, then it is known as the devaluation of the currency. Under this, the value of the domestic currency is deliberately reduced in terms of other foreign currencies.
  • For example, in 1966 when the India was following the fixed exchange rate regime, the Indian Rupee was devalued by 36 %. Depreciation of a currency
  • Depreciation of a currency is a phenomenon associated with countries with floating exchange rate regime. In the floating exchange rate regimes, the value of a country's currency is determined by the market forces of demand and supply.
  • The exchange rate of the currency changes on daily basis as per the demand and supply of that currency with respect to foreign currencies. A currency depreciates with respect to foreign currency when the supply of currency in the market increases while its demand falls.
Revaluation
  • Revaluation refers to an upward adjustment to the country's official exchange rate the relative to either price of gold or any other foreign currency.
  • Revaluation increases the value of the domestic currency with respect to the foreign currency.
  • Revaluation is a feature of the fixed exchange rate regime, where the exchange rate is determined by the central bank or the government. Revaluation is opposite to devaluation, which is a downward adjustment. Currency Appreciation
  • Currency appreciation refers to the increase in the value of one currency with respect to other foreign currencies due to market forces of demand and supply
  • Currency appreciation is the unofficial increase in the value of any currency.
  • It is a feature associated with floating or managed floating exchange rate regimes. Appreciation of a currency takes place when the supply of the currency is lesser than its demand in the foreign exchange market.
Convertibility
  • Current account is Fully Convertible (Foreign currency to Rupee).
  • Capital account is not fully convertible (Many Restriction).
S.S Tarapore Committee to propose a roadmap for full convertibility of the rupee. Fully current account convertibility and slowly capital convertibility attain full Convertibility.
Reserves of RBI
  1. Rupees (For OMO, Give to Govt, Monetary policy)
  2. Foreign Exchange Reserves
  3. G-Sec
Foreign Exchange Reserves
  1. Foreign currency (Mostly Hard Currency).
  2. Gold (No need to saving in RBI alone, Gold saving also in other country’s federal bank).
  3. Special Drawing Rights (SDR) – on IMF.
  4. Reserve Tranche – on IMF.
(3 & 4 is maintained in IMF)
Some Concept
  • Hard Currency – Currency has highest demand in the world [Euro, Japan, UK, USA, Hong Kong, China
  • Soft Currency – Other Currency (like Rupee)
  • Phenomenon
    • Hot Currency - Currency getting strong
    • Heated Currency – Currency feeling the heat of Hot currency
(Doller value strengthening compare to Indian Rupee (1$=70 to 1$=80). Doller is Hot currency; Rupee is heated currency. If Rupee is Strengthening compare to Dollar (1$=70 to 1$=60. Rupee is Hot currency; Dollar is heated currency).

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