What is Foreign Exchange?
In our own town, we usually pay for our purchases in coins or notes.
Sometimes, if the deal is a bit large, we pay through a cheque on some local bank.
If we have to remit money to a distant place like Bombay, we may utilise the services of a post office for sending a money order or issue a cheque or send a bank draft. But if we have to make payment to a foreigner say, in New York, the matter becomes complicated.
The Americans will not accept our rupees. And we have no dollars with us in India to pay them. We shall have to call on our banker to change our rupees into dollars and remit them to New York. This change of rupees into dollars (or any other currency), and vice versa, is called Foreign Exchange. By ‘foreign exchange’, we also mean a reserve or a fund of foreign currency.
Mode of Foreign Payments:
Payment for imports to the foreign exporter can be made through:
(a) Bill exchange,
(b) Banker’s draft, and
(c) Cable or telegraphic transfer.
These three—bills, banker’s drafts and cable transfers in favour of a country or against it—appear as demand and supply in exchange markets. Let us suppose there are only two trading countries, India and the U.S.A. There would be bills and drafts in favour of India for her exports to the U.S.A. and those against her for her imports at any time.
If the bills in favour of India exceed in value those drawn against her, there will be greater demand for rupees than their supply. The value of the rupee will rise in terms of the dollar, i.e., the rate of exchange will move in favour of India. This will mean that less number of rupees will have to be paid per dollar to obtain a certain amount of dollars. In opposite circumstances, the value of the rupee will fall.
There are, however, not two countries but many. Every country has a different currency and there is no common medium of exchange. Hence, only gold or silver can be acceptable to all, but actually gold and silver too are like other goods. All goods and services imported, including gold and silver, have to balance against those exported over a long period.
This balancing is done by bills of exchange. It is this feature which distinguishes international trade from home trade. All imports, including goods and services, have to be met by exports. Hence international trade is rightly said to be a form of barter.
Rate of Exchange:
The rate at which a unit of one country exchanges for the currency of another is the rate of exchange between them. The Indian rupee at present November 25, 1983 exchanges for Britain’s 62 pence and for U.S. 9.5 cents. To put it differently, $1 = Rs. 10.40 and £1 = Rs. 15.30. This is our rate of exchange with the U.S.A. and U.K. respectively. However, it keeps on fluctuate from day to day.
Every country has a currency different from others. There is no common medium of exchange. It is this feature that distinguishes international from domestic trade. When the imports and exports of a country are equal, the demand for foreign currency and its supply, or, conversely, the supply of home currency and the demand for it will be equal.
The exchange will be at par. If the supply of foreign money is greater than the demand, it will fall below par and the home currency will appreciate. If, on the other hand, the home currency is in greater supply, there will be keener demand for the foreign currency. The latter will appreciate in value and rise above par.