India is following the direct rate in Forex markets, i.e. foreign currency is fixed and home currency is varying. When we go to a shop and ask for the price of a product he tells us only one rate for the product, because the trader is only selling the product to consumers. He is not buying from consumers. Whatever rate the seller tells is implied as his selling price for the product. Even though the consumer is buying a product, what he pays to the trader is the selling price of the trader. Foreign Exchange market is different from this market in the sense that the authorized dealer buys as well as sells the foreign currency. Banks and financial institutes authorized by RBI to sell the foreign currency are called as Authorized Dealers. When you ask the rate of a foreign currency from an authorized dealer, he quotes two- way rates. It means that he quotes the rate for buying as well as selling the foreign currency.
Example US$ 1=Rs.45.2200,45.2300
In this rate, the authorized dealer will buy US$ at the rate of US$ 1=45.2200 and he will sell the US$ at the rate of US$ 1=Rs.45.2300. The difference between the buying and selling price is his profit margin. Here, the dealer will make a profit of Rs.0.0100 by buying and selling one US dollar. Even though, the word “Buying rate” and “Selling rate” is not mentioned in the quotations, it is implied that the lesser rate is the buying rate and that the higher rate is the selling rate. Buying and selling should be seen from the dealer point of view.
If you want to sell the dollars the rate applicable will be US $ l=Rs.45.2200. If you are selling, it means the dealer is buying foreign currency from you. Therefore, his buying rate should be taken. If you want to buy the dollars, the rate applicable will be US$ 1=Rs.45.2300. If you are buying, it means that the dealer is selling foreign currency to you. Therefore, his selling rate should be taken.
- Normally exporters sell the foreign currency and importers buy the foreign currency.
- If the exchange rate changes from US$ 1=45.50 to US$ 1 = 44.50, it is called appreciation of the Rupee, because you have to pay fewer rupees to buy a US$ compared to the earlier rate.
- If the exchange rate changes from US$ 1=45.50 to US$ 1 = 46.50, it is called depreciation of the Rupee, because you have to pay more rupees to buy a US$ compared to the earlier rate.
- Before the commencement of Financial Sector Reforms, the rupee was regularly depreciating against the US$ with the passage of time. But, now the exchange rates are quite stable.
- All Forex transactions in India are to be routed through banks who are authorized by the Reserve Bank of India to do so. The banks buy and sell various foreign currencies to make a profit. The transaction in which a bank acquires foreign currency is a buying transaction from the bank’s point of view and the bank will apply the prevailing buying rate for conversion. The transaction in which the bank parts with foreign currency is a selling transaction from the bank’s point of view and the bank will apply the prevailing selling rate for conversion.
Various types of Forex transactions undertaken by banks can be broadly classified in to eight types, as under:
- Inward remittances
- Export
- Encashment of foreign currency travellers cheques
- Encashment of Foreign currency notes
- Outward remittances
- Imports
- Issuing Foreign currency travellers cheques
- Issuing Foreign currency notes
While the first four Forex transactions are of a buying nature from the bank’s point of view (as the bank is going to acquire foreign currency), the latter four Forex transactions are of a selling nature from the bank’s point of view (as the bank is going to part with the foreign currency). For each type of above transactions, the bank will apply a separate rate for conversion.
Credit: International Finance-MGU MBA