Foreign currency refers to all currencies except the domestic currency of a country. For example, the US dollar is a foreign currency for India and rupee is a foreign currency for the US.
Foreign currency exchange refers to trading or conversion of one country’s currency into another country’s currency.
Owing to the advent of new monetary technologies, modernization is taking place at a hasty pace. With the establishment of the world economy, an increase in business transactions and trade among countries, foreign currency exchange is playing a fundamental role. It is also called the ‘backbone’ of global trading because it provides a common measure of value and makes all this possible.
Foreign exchange works both online and physical. The amount of exchange in a day depends on the international ‘spot rate ‘which is a value fixed to trade currencies within one or two business days.
Reasons for the demand for foreign exchange:
- In this era of the international economy where countries trade goods and services foreign exchange is required to make payment of such services. The value of one country’s currency will not be equal to the value of another country’s currency. Hence, to overcome this obstacle, the foreign currency exchange in Delhi market (or Forex) was established where currencies can be traded as required. In other words, it exchanges the purchasing power of countries. Forex is considered as the largest financial liquid market in the whole world. The foreign currency exchange market consists of commercial banks, central banks, multinational corporations, investment managers and few individual investors. Hence it is a large team of individuals who manage foreign exchange among nations.
- Foreign exchange is also required because developing countries have to maintain their foreign currency reserves to tackle any future economic obstacles. Only a country with large foreign withholds will remain stable during a fiscal crisis.
- It is also required when a domestic company wants to establish a business in another country. It will have to make payment in the local country’s currency.
Reasons for the supply of foreign exchange:
- Supply refers to the inflow of foreign exchange. Consumers want to consume products made overseas and for this import of goods and services, a country needs foreign exchange to make payment.
- Foreign exchange is also required by foreign investors who want to invest in the domestic country.
Who regulates foreign currency exchange in India?
The foreign currency exchange in India is governed by the Foreign Exchange Management Act (FEMA) 1999. According to this act, the Reserve Bank of India (RBI) has the exclusive and sole authority to regulate the foreign exchange of India. It is also responsible for all the key approvals in matters regarding foreign exchange.
The rate at which currencies can be exchanged is called ‘Foreign exchange rate’ which is determined by the market forces and keeps on fluctuating. There are two kinds of exchange rate:
- Fixed exchange rate system: In this exchange system, the exchange rate is fixed and regulated by the government. It ensures stability in the international monetary market and reduces risk due to no fluctuations in the exchange rate.
- Flexible exchange rate system: In this specific exchange system, the exchange rate is allowed to fluctuate freely as required by the market forces of demand and supply. Owing to the frequent fluctuations, there is instability in the international money market and has high levels of risk.
It is pretty much clear that the foreign currency exchange regulations are structured in a unique way to protect the domestic interests of the country. Such policies will remain in effect until the country has enough foreign exchange reserves to overcome any kind of budgetary disaster. Efficient and systematic regulations can help increase transparency in the system.