Bird's-eye view on Foreign Exchange Management [FEMA] by CS Aakanchha vyas

All about Foreign Exchange Management:

In simple words foreign exchange management means the management of generation, use and storage of foreign currencies. Foreign exchange is the largest financial market in the world. Every firm and individual operating in international environment is concerned with foreign exchange i.e the exchange of foreign currency into domestic currency and vice-versa. Each country in the world has its own currency. Currency of a country is used for transactions with foreigners.

Forex is generated from the international trade transactions. When a country exports good or services, it earns Forex. When goods and services are imported by a country, forex is consumed. If the exports of a country are more than the imports, the Forex would be accumulated in reserves of the country. If the imports are more than the exports, the result would be a Forex deficit which has to be met by international borrowings. Generation of Forex is very difficult proposition because of variation in international trade practices and extent of competition.

  • Importance of Forex Management:-

The significance of forex management lies in the study and maintenance of the exchange levels. Forex management become a more important because of increased globalization of financial markets. At present most of the countries are economically related to each other through a complex network of trade, foreign investment and international loans. The process of global integration has reinforced the importance of international trade, cross border financial flows and consequently foreign currency transactions. With the advent of globalization and liberalization the scope for international trade and financing has increased tremendously. International trade has grown more quickly than trade in general. The principal benefit for international trade is in the form of the gain in standard of living, efficiencies of productions in different countries.

  • Foreign Exchange Market and its Structure:-

Foreign exchange transaction means the sale and purchase of foreign currencies. Foreign exchange market provides a mechanism for transfer of purchasing power from one currency to another. This market is not physical entity like the stock exchange or trading center, it is network of telephones among banks, foreign exchange dealers and brokers etc. The market is an over the counter market. The dealers sit in their dealing room of major commercial banks around the world and communicate with each other through telephones, computer terminals and society for Worldwide Inter Bank Financial Telecommunication (SWIFT) mechanism. This is a non- profit Belgian cooperative with main and regional centers around the world connected by data transmission lines. Depending on the location a bank can access a regional processor or a main centre which then transmits the information to the appropriate location.

The forex market is a wholesale market called the inter-bank market. Commercial banks are the market makers. Corporations use the foreign exchange market for a variety of purposes relating to their operation like payment of imports, conversion of export receipts, hedging of receivables and payables, currency loans, placement of surplus fund etc.

Forex market operates at three levels. At first level are the currency dealers or money changers who provide for encashment of travelers cheque and release of small amount to travelers. At second level the spot foreign exchange market, involved with the exchange of currencies held in different currency denominated bank accounts. The inter- bank  foreign exchange market is the largest financial market in the world.

Participant of Forex Market:-

•    Authorize money changers
•    Authorize dealer in foreign exchange
•    Foreign exchange dealer Association of India

Determination of Exchange Rate:-

Factors involved in the determination of exchange rate are as follow:-

  1. Balance of payments
  2. Demand and supply
  3. Purchasing power
  4. Interest rate
  5. Relative income levels
  6. Market expectations.
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