PART=C

1  What is Foreign Exchange? 

 
Foreign Exchange is the mechanism of converting one country’s currency into 
another country currency. 
2  What is Exchange Rate? 
 
Exchange  Rate  is  the  rate  at  which  one  currency  is  converted  into  another 
currency.  In  other  words,  Exchange  rate  – the rate at which a currency can be 
exchanged. It is the rate at which one currency is sold to buy another 
Exp:  US  $  1  =  Rs.53.00  i.e  One  US  Dollar  is  equaling  to  Indian  Rs.53.00.  In 
other  words,  if  one  tenders  Indian  Rupees  of  Fifty  three  can  get  One US Dollar 
and vice versa. 
 
3  What are the factors that determines the value of the Currency? 
 
We  are  not  going  deep  dive  into  economic  terms  to  understand  the  currency 
value  fluctuation.  There  are  many  factors  to  decide  the  currencies  values  but 
that  could  be  very  difficult  for  the  common  man  to  understand  the  theory. 
Here  I  will  put  it  in  the  simple  words  why  the  currency  value  is  often 
fluctuated.  A  currency  will  tend  to  become  more  valuable  when  its  demand  is 
higher  than  supply.  A  currency  will  tend  to  become  less  valuable  when  its 
demand is less than supply. It is the basic theory. We need to understand in the 
global  economy  terms,  when  the  currency  will  have  more  demand and when it 
will have less demand. 
 
Remember  that  exchange  rates  are  expressed  as  a  comparison  of  two 
currencies.  It  is  always  relative  and  can  be  measured  between  two  countries. 
Interest  rates,  Inflation  and  exchange  rates  are  highly  related.  Reserve  bank 
change the interest rates to control the Inflation and exchange rates. 
 
We  can  take  our  real  time  example  of  stock  market  investment  to  understand 
the  above  principle.  As  we  know  that,  our  stock  market  is  dominated  by  the 
overseas  investors  (outside  India),  because  of  the  our  growing  economy  and 
industrial  development.  When  our  economy  is  doing  well  and  market  is 
performing  better  than  other  countries,  overseas  investors  would  invest 
heavily  on  our  market.  How  they  would  put  it  in  our  market?.  They will sell or 
convert to our currency and invest in India. It is clear that when more investors 
coming  to  India,  the  demand  for  the  currency  will  be  very  high.  Our  rupee 
value  will  be  increased  against  dollar.  In  the  same  way,  when  they  are  pulling 
out  of  market,  demand  for  the  rupee  will  be  decreased  and  value  is 
depreciated. 
 
Here  I  am  talking  only  about  the  dollar,  because  it  is  the  global  currency  and 
most  of  the  countries  trading  using  the  dollar  as  trade  reserve  currency.  The 
above  example  is  given  to  explain  it  in  simple  words,  the  demand  for  a 
 currency  would  come  in  the  different  way.  When  we  are  importing  from other 
countries,  we  should  have  the  currency  of  that  country  to  pay  for  the  trade. 
The value for the currency is fluctuated on real time. 
 
If a currency is free-floating, its exchange rate is allowed to vary against that of 
other  currencies  and  is  determined  by  the  market  forces  of  supply  and 
demand.  Exchange  rates  for  such  currencies  are  likely  to  change  almost 
constantly  on  financial  markets,  mainly  by banks, around the world. A movable 
or  adjustable  peg  system  is  a  system  of  fixed  exchange  rates,  but  with  a 
provision  for  the  devaluation  of  a  currency.  For  example,  between  1994  and 
2005,  the  Chinese  yuan  renminbi  (CNY,  ¥)  was  pegged  to  the  United  States 
dollar at ¥8.2768 to $1. 
 
4   
5  What is Current Account Convertibility? 
 
Current  account  convertibility  allows  free  inflows and outflows for all purposes 
other  than  for  capital  purposes  such  as  investments  and  loans.  In  other words, 
it  allows  residents  to  make  and  receive  trade-related  payments  --  receive 
dollars  (or  any other foreign currency) for export of goods and services and pay 
dollars  for  import  of  goods  and  services,  make  sundry  remittances,  access 
foreign currency for travel, studies abroad, medical treatment and gifts, etc. 
 
6  What is Capital Account Convertibility? 
 
There  is  no  formal  definition  of  capital  account  convertibility  (CAC).  The 
Tarapore  committee  set  up  by  the  Reserve  Bank  of  India  (RBI)  in  1997  to  go 
into  the  issue  of  CAC  defined  it as the freedom to convert local financial assets 
into  foreign  financial  assets  and  vice  versa  at  market  determined  rates  of 
exchange.  
In  simple  language  what  this  means  is  that  CAC  allows  anyone  to  freely  move 
from local currency into foreign currency and back. 
 
To  put  is  simply,  capital  account  convertibility  (CAC)  --  or  a  floating  exchange 
rate  --  means  the  freedom  to  convert  local  financial  assets  into  foreign 
financial  assets  and  vice  versa  at  market  determined  rates  of  exchange.  This 
means  that  capital  account  convertibility  allows  anyone  to  freely  move  from 
local currency into foreign currency and back.  
 
It  refers  to  the  removal  of  restraints  on  international  flows  on  a  country's 
capital  account,  enabling  full  currency  convertibility  and  opening  of  the 
financial system. 
A  capital  account  refers  to  capital  transfers  and  acquisition  or  disposal  of 
non-produced,  non-financial  assets, and is one of the two standard components 
of  a  nation's  balance  of  payments.  The  other  being the current account, which 
refers to goods and services, income, and current transfers. 
 
Capital account convertibility is considered to be one of the major features of a 
developed  economy.  It helps  attract  foreign  investment.  It  offers  foreign 
investors  a  lot  of  comfort  as  they  can  re-convert  local  currency  into  foreign 
currency anytime they want to and take their money away. 
 
At  the  same  time,  capital  account  convertibility  makes  it  easier  for  domestic 
companies  to  tap  foreign  markets.  At  the  moment,  India  has  current  account 
convertibility.  This  means  one  can  import and export goods or receive or make 
payments  for  services  rendered.  However,  investments  and  borrowings  are 
restricted. 
Even  the  World  Bank  has  said  that  embracing  capital  account  convertibility 
without  adequate  preparation  could  be  catastrophic.  But  India  is  now  on  firm 
ground  given  its strong financial sector reform and fiscal consolidation, and can 
now slowly but steadily move towards fuller capital account convertibility. 
 
How is CAC different from current account convertibility?  
 
Current account convertibility allows free inflows and outflows for all purposes 
other than for capital purposes such as investments and loans. In other words, 
it allows residents to make and receive trade-related payments — receive 
dollars (or any other foreign currency) for export of goods and services and pay 
dollars for import of goods and services, make sundry remittances, access 
foreign currency for travel, studies abroad, medical treatment and gifts etc. In 
India, current account convertibility was established with the acceptance of 
the obligations under Article VIII of the IMF’s Articles of Agreement in August 
1994.  
 
Can CAC coexist with restrictions? 
 
Contrary  to  general  belief,  CAC  can  coexist  with  restrictions  other  than  on 
external  payments.  It  does  not  preclude  the  imposition  of  any  monetary/fiscal 
measures  relating  to  forex  transactions  that  may  be  warranted  from  a 
prudential point of view.  
 
Why is CAC such an emotive issue?  
 
CAC  is  widely  regarded  as  one  of  the  hallmarks  of  a  developed  economy.  It  is 
also  seen  as  a  major comfort factor for overseas investors since they know that 
anytime  they  change  their  mind  they  will  be  able  to  re-convert  local  currency 
back into foreign currency and take out their money.  
In  a  bid  to  attract  foreign  investment,  many  developing  countries  went  in  for 
CAC  in  the  80s  not  realising  that  free  mobility  of  capital  leaves  countries open 
to  both  sudden  and  huge  inflows  as  well  as  outflows,  both  of  which  can  be 
potentially  destabilising.  More  important,  that unless you have the institutions, 
particularly  financial  institutions,  capable  of  dealing  with  such  huge  flows 
countries  may  just  not  be  able  to  cope  as  was  demonstrated  by  the  East  Asian 
crisis of the late nineties.  
 Following  the  East  Asian  crisis,  even  the  most  ardent  votaries  of  CAC  in  the 
World  Bank  and  the  IMF  realised  that  the  dangers  of  going  in  for  CAC  without 
adequate  preparation  could  be  catastrophic.  Since  then  the  received  wisdom 
has  been  to  move  slowly  but  cautiously  towards  CAC  with  priority  being 
accorded to fiscal consolidation and financial sector reform above all else.  
 
In  India,  the  Tarapore  committee  had  laid  down  a  three-year  road-map  ending 
1999-2000  for  CAC.  It  also  cautioned  that this time-frame could be speeded up 
or  delayed  depending  on  the  success  achieved  in  establishing  certain 
pre-conditions  —  primarily  fiscal  consolidation,  strengthening  of  the  financial 
system  and  a  low  rate  of  inflation.  With  the  exception  of  the  last,  the  other 
two pre-conditions have not yet been achieved.  
 
What is the position in India today?  
 
Convertibility  of  capital  for  non-residents  has  been  a  basic  tenet  of  India’s 
foreign  investment  policy  all  along,  subject  of  course  to  fairly  cumbersome 
administrative  procedures.  It  is  only  residents  —  both  individuals  as  well  as 
corporates  —  who  continue  to  be  subject  to  capital  controls.  However,  as  part 
of  the  liberalisation  process  the  government  has  over  the  years  been  relaxing 
these  controls. Thus, a few years ago, residents were allowed to invest through 
the  mutual  fund  route  and corporates to invest in companies abroad but within 
fairly conservative limits.  
 
Buoyed  by  the  very  comfortable  build-up  of  forex  reserves,  the  strong  GDP 
growth  figures  for  the  last  two  quarters  and  the  fact  that  progressive 
relaxations  on  current  account  transactions  have  not  lead  to  any  flight  of 
capital,  on  Friday  the  government  announced  further  relaxations  on  the  kind 
and  quantum  of  investments  that  can  be  made  by  residents  abroad.  These 
relaxations  are  to  be  reviewed  after  six  months  and  if  the  experience  is  not 
adverse,  we may see further liberalisation and in the not-too-distant future full 
CAC. 
 
7  How Capital Convertibility affects you? 
 
As  most  of  us  know,  resident  Indians  cannot  move  their  money  abroad  freely. 
That  is,  one  has  to  operate  within  the  limits  specified  by  the  Reserve  Bank  of 
India and obtain permission from RBI for anything concerning foreign currency. 
 
For  example,  the  annual  limit  for  the  amount  you  are  allowed  to  carry  on  a 
private  visit  abroad  is  $10,000:  of  which  only  $5,000  can  be  in  cash.  For 
business  travel,  the  yearly limit is $25,000. Similarly, you can gift or donate up 
to $5,000 in a year. 
The  RBI  limit  raises  the  limit  if  you  are  going  abroad  for  employment,  or  are 
emigrating to another country, or are going for studies abroad: the limit in both 
these cases is $100,000. 
You  are  also  allowed  to  invest  into  foreign  stock  markets  up  to  the  extent  of 
$25,000 in a year. 
 For  the  average  Indian,  these  'limits'  seem  generous  and  might  not  affect  him 
at  all.  But  for  heavy  spenders  and  those  with  visions  of  buying  a  house  abroad 
or a Van Gogh painting, it will mean a lot. . . 
But  with  the  markets  opening  up  further  with  the  advent  of  capital  account 
convertibility,  one  would  be able to look forward to more and better goods and 
services. 
8  Euro Currency? 
 
The  euro  is  the  currency  used  by  the  16  European  Union  countries.  The  euro 
was  launched  on  January  1,  1999.  The  currency  is  the  second  most  traded 
currency  after  the  US  dollar.  The  currency  is  used  by  around  329  million 
people.  The  countries  that  use  the  euro  are  Finland,  Austria, Belgium, Cyprus, 
France,  Germany,  Greece,  Ireland,  Italy,  Luxembourg,  Malta,  the  Netherlands, 
Portugal,  Slovakia,  Slovenia and Spain. If you are planning a trip to Europe then 
the euro is the currency you will need for most of the locations you visit. There 
are  additional  countries  that  will  accept  the  euro  even  though  there  is  no 
formal agreement to do so. 
 
The  euro  is  managed  and  administered  by  the  ​Frankfurt​-based  ​European 
Central  Bank  (ECB)  and  the  ​Eurosystem  (composed  of  the  ​central  banks  of  the 
eurozone  countries).  As  an  independent  central  bank,  the  ECB  has  sole 
authority  to  set  ​monetary  policy​.  The  Eurosystem  participates  in  the  printing, 
minting  and  distribution  of  ​notes  and  ​coins  in  all  member  states,  and  the 
operation of the eurozone payment systems. 
 
The  name  euro  was  officially  adopted  on  16  December  1995.[8]  The  euro  was 
introduced  to  world  financial  markets  as  an  accounting  currency  on  1  January 
1999,  replacing  the  former  ​European  Currency  Unit  (ECU)  at  a  ratio  of  1:1. 
Euro ​coins​ and ​banknotes​ entered circulation on 1 January 2002.[9] 
 
9  What is Rupee Appreciation? 
 
Rupee  is  the  Indian  currency.  Just  like  any  commodity  the  Rupee  also  has  a 
price,  the  value  you  pay  to  exchange  a  rupee.  The  US  Dollar  being  the 
predominant  currency,  all  prices  of  currencies  are  generally  quoted in Dollars. 
Hence  in  case  of  the  Rupee,  its  price  at  any  point  in  time  maybe  say,  US $ 1 = 
Rs.45  (determined  through  various  aspects  such  as  forex reserves, FDI inflows, 
rate  of  interests  and  so  on).  With  the  change  of  the indicators the value of the 
rupee  as  per  the  dollar  changes.  When  the  rupee  becomes dearer i.e. say US $ 
=  Rs.40  it  is  said  to  have  Appreciated  (Value)  in  the  reverse  case  say  US  $  = 
Rs.50 then the Rupee Depreciates (Value).  
Rupee  changes  values  for  a range of reasons, like if US performs very well then 
people  will  demand  more  US  dollars,  exchanging  their rupee. This Demand will 
raise the price of the US dollar and hence depreciate the Indian Rupee. 
 
[The  dollar  has  been  the  popular  medium  of  foreign  exchange  for  a  long  time. 
Most  of  the  payment  for  the  export  or  import  is  made  through  dollar.  If  we 
analyses  Rupee  appreciation in terms of Dollar --  In case of Rupee appreciation 
 the  value  of  the  Dollar  is  depreciated  i.e  for  purchase  of  Dollar  against  Indian 
Rupee lesser amount of rupees are required. 
  For  Example,  in  normal  trend  the  market  rates  of  Dollar – Rupee are at  US $ 
1  =  Rs.45.00.  In  case  of  Rupee  appreciation,  the  Dollar  –  Rupee  rates  will  be 
US  $  1  =  43.00  /  42.50  /  40.00  like  that.  Since  the  value  of  Rupee  is 
appreciated,  by  payment  of  Lesser  units  of  Indian  Rupees  one  can  get  US 
Dollars in the market.] 
 
The mechanism is the same in any Currency.   
Appreciating  Rupee  means  that  now  the  Dollar  is  now  cheaper  than  what  it 
used  to  be  earlier  (from  $1~50  Rs,  now  to  40  Rs.),  in  other  words you can buy 
more  from  the  international  market  spending  the  same  amount  of  Rupees. 
There  are  very  direct  effects  of  the  appreciating  Rupee  in  both  national  and 
international scenarios. 
 
To  put  it  simply  we  must  consider  the  whole  situations  through  two  points  of 
view: Import and Export 
 
Import:  When  you  import  (buy  from  foreign  markets) goods, you have to pay in 
dollars.  India's  chief  import  is  crude  oil.  Suppose  a  barrel  of  oil  costs  $100,  as 
per  earlier  rates  a  company would have to pay about 4800 rupees($1=48 Rs) to 
buy  a  barrel,  now  can  buy  the  same  for  4000  Rs  ($1=40  Rs.).  so  oil  companies 
are  the  biggest  gainers  from  the  appreciating  rupee.  They  are  now  getting  oil 
at  reduced  prices  but  selling  them  to  the  customers  at  old  rates,  hence 
increasing their profits. 
 
Export:  When  you  sell  goods/services  in  foreign  market  you  get  payed  in 
dollars.  A  lot  of  companies  that  have  been  asking  the  govt.  and  RBI  for control 
of  the  appreciating  rupee,  are  export  driven  companies  like  big  IT  cos.  who 
export  software  solutions  and  provide  out-sourcing  services.  There  are  many 
others  too  like  garment  exporters  and  even  automotive  companies.  the  scene 
here  is  that,  supposing  a  BPO  company  charged  $100  for  its  services,  it  would 
be  getting  payed  an  equavalent  amount  to  Rs  4800  as  per  old  exchange  rates, 
but  because  of  the  appreciating  rupee,  it  now  gets  payed  Rs  4000,  and  as  the 
market  gets  increasingly  competative  the  company  cannot  increase  the  fee  it 
charges  the client to $120 to cover this loss, as it risks losing the client to some 
other  company.  Garment  exporters  are  hit  even  stronger  as  they  mostly 
survive  on  large  dedicated  orders  and  charging  more  to  cover  their  losses  can 
even  result  in  cancellation  of  large  orders  and  massive  loss  to  a  garment 
exporter. 
 
 
10  What is Rupee Depreciation? 
 
In case of Rupee Depreciation, for purchase of US Dollar more units of Indian 
Rupees have to be paid. Exp: US 1 = Rs.45.00 / 46.50 / 47.00 / 50.00 like 
this the trend.  
 Since the value of Rupee is Depreciated, by payment of more units of Indian 
Rupees one can get US Dollars in the market.] 
 
The mechanism is the same in any Currency.   
 
11  Make a study on Rupee Appreciation and Depreciation? 
 
Indian economy is among the fastest growing economies of the world. The 
appreciation of the rupees against the dollar would be another giant sign 
towards its economic prosperity and augmentation. However, the economic 
epidemics like poverty, unemployment etc., could not be dealt in the 
short-run. 
 
The appreciation of the rupees will help the economy in many ways. There will 
be positive impact on importers and negative impact on the exporters. Let us 
evaluate the possible impact of the devaluation of dollar and appreciation of 
rupees on the export & import in India. The dollar has been the popular 
medium of foreign exchange for a long time. Most of the payment for the 
export or import is made through dollar. 
 
The depreciation of the dollar will have a positive impact on the importers, 
while it will have adverse effect on the exporters. Importers of goods and 
services will be getting the goods and services by paying less, as they used to 
pay 47 rupees against one dollar, now they will be paying around 39 to import 
the same. The exporter will be getting their return in dollar at the cost of 39 
rupees per 1 US dollar, whereas they used to get around 47 rupees against one 
dollar. The difference in the previous and present exchange would have high 
impact if the volume of exchange is in millions of rupees or dollars. 
 
In the past one year, the dollar has dropped by around 20 per cent against 
Indian rupees. This reveals that positive or negative impact on volume of 
export or import would be around 20 per cent, which can not be over looked 
as the exporters are suffering losses, whereas importer are on gain. However 
the impact will remain until there is depreciation of dollar against rupees. If it 
continues, then a great change can be expected on a long run in international 
trade arena. Another impact would be the fantasy of dollar has been losing 
ground day by day. 
 
Analyses made it clear that earlier people were fascinate about dollar due to 
its value against Indian rupees. But the scenario has completely changed. 
Those, who were planning to move to US for job, now might plan to settle in 
Britain, as British economy is one of the strongest economies in the world. 
 
The appreciation of the rupees will have a positive impact, whereas in the 
global economy the Yen, Euro and other currencies would find place in the 
foreign exchange race. At the international level, the sliding dollar will have 
huge impact as it is the global player despite all the hiccups. Finally it would 
 worthwhile to say - depreciation of dollar: a million rupees question. 
 
 
The Appreciation of rupee affects the exporters who are trading outside India 
had contract with Foreign buyers, According to them, this Rupee Appreciation 
affects their business very much. Because, They made a contract with Buyers 
say before 1 or 2 or 3 years, they agreed to supply Garments at Rs.48/- (Thats 
a Dollar) for a piece, Now the rate is decreased to Rs.43/-, so, they are losing 
Rs.5/- per piece, then calculate the amount of loss for them. 
 
So, According to them this is bad. 
 
12  Explain about the Indian foreign exchange rate system? 
 
Indian foreign exchange rate system – India FX rate system was on the fixed 
rate model till the 90s, when it was switched to floating rate model. Fixed FX 
rate is the rate fixed by the central bank against major world currencies like 
US dollar, Euro, GBP, etc. Like 1USD = Rs. 40. Floating FX rate is the rate 
determined by market forces based on demand and supply of a currency. If 
supply exceeds demand of a currency its value decreases, as is happening in 
the case of the US dollar against the rupee, since there is huge inflow of 
foreign capital into India in US dollar 
 
13  Why is the US dollar walking down? – 
  
When it comes to the US being a consumer, it has one of the largest appetites 
in the world. To keep up its demand for consumption, its imports are huge 
when compared to exports. This created pressure since there were more 
payments in dollars than receipt of any other currency, which made the supply 
of the dollar greater for imports payment and less receipt of foreign currency 
from exports. This resulted in the depreciation of the dollar’s value, which 
again caused more outflow of dollar for import payments. This created a state 
of inflation and made consumables costlier to US. To control inflation US 
resorted to increase in interest rates to cool down pressure on demand side of 
consumption. This factor along with recession in all other sectors, particularly 
real estate, is causing the mighty US dollar to shake 
14  Impact of dollar fluctuations on the Indian economy ? 
 
Until the 70s and 80s India aimed at to be self-reliant by concentrating more on 
imports and allowing very little exports to cover import costs. However, this 
could not last long because the oil price rise in the 1970s and 80s created a big 
gap in India’s balance of payment. Balance of payment (BOP) of any country is 
the balance resulting from the flow of payments/receipts between an 
individual country and all other countries as a result of import/exports 
happening between an individual country, in our case India and rest of the 
world. This gap widened during Iraq’s attempt to take over Kuwait. Thereafter, 
exports also contributed to FX reserve along with Foreign Direct Investment 
into the Indian economy and reduced the BOP gap. 
  
Indian rupee appreciation against dollar impacted heavily to the following: 
 
Exporters  
Importers  
Foreign investors  
 
Exports from India are of handicrafts, gems, jewelry, textiles, ready-made 
garments, industrial machinery, leather products, chemicals and related 
products. Since the 1990s, India is the world’s largest processor of diamonds. 
The mentioned export items contribute substantially to foreign receipts. 
During the periods when the dollar was moving high against the rupee, 
exporters stood to gain, when $1 = Rs. 48, was getting them Rs. 4800 for every 
$100. Since the beginning of the year 2007, rupee appreciated by about 10%. 
With its value of rupee Rs. 39.35 = $1 as on 16 Nov 2007, for every $100, 
exporters would get only Rs. 3935. This difference is towing away the profit 
margins of exporters and BPO service providers alike. 
 
Imports to India are of petroleum products, capital goods, chemicals, dyes, 
plastics, pharmaceuticals, iron and steel, uncut precious stones, fertilizers, 
pulp paper etc. With the same scenario as given for export, if we analyze - an 
importer is paying Rs. 3935 now instead of Rs. 4800 paid during yester years 
for every $100. This gain on FX is likely to create savings in cost, which could 
be passed on to consumers, thereby contributing to control inflation. 
 
Foreign investment into India is also contributing well to dollar depreciation 
against Rupee. With the recent liberalized norms on foreign investment policy 
like – Foreign investment of up to 51% equity limit in high priority industries; 
foreigners & NRIs are allowed to repatriate their profits and capital with 
exception for Indian nationals who were allowed to do so only under special 
circumstances; allowing free usage of export earnings to exporters, made 
foreign investment in India very attractive. It is this favorable atmosphere 
which made FX reserve surplus in US dollar and helped rupee to appreciate. 
 
Conclusively, appreciation and depreciation of rupee cannot certainly be taken 
as beneficial to the Indian economy in general. On one hand the rupee 
appreciation will affect exporters, BPOs, etc., on the other, rupee depreciation 
will affect importers. So now it depends on what the future has to reveal for, 
how effectively the central bank can balance the FX rates with little impact to 
the relative areas of FEX usage. Can the Dollar remain king or not, is no longer 
a million dollar question, but a million Rupee question! 
 
   
15  What is Sovereign Debt?. Have you heard of the word Sovereign Debt ? 
 
If you are watching the financial news regularly or you are the one avid 
financial reader then you must have heard about the term Sovereign Debt and 
problems arising out of excess sovereign debt on each countries. It is very 
difficult for every one or the normal person without the good knowledge on the 
economy to understand the meaning of the complicated jargon like Sovereign 
Debt. 
 
It is my personal opinion that although you are not the finance person, it is 
wise to improve the basic knowledge on the things which would impact our 
life. This article would explore the more facts related to Sovereign Debt and 
what will be the impact in our life if the problem is not solved on time.  
 
What is Sovereign Debt? 
 
Before knowing about the sovereign debt, you must know about the other two 
terms Sovereign Bond and Government Bond. 
 
Government Bonds 
Bonds are debt instruments issued by the government, banks, companies to 
raise the money from public. This money will be used for meeting the future 
expenses, expansion plans for the companies, building infrastructure for the 
country, etc. In short, the bond holders are the lenders to the bond issuers. 
 
When government is in short of money, it will issue the bonds in its local 
currency or the international currency. If the bonds are in the local currency, 
it is called as the Government Bonds. People would be more interested in 
buying the government bonds because of its high security and returns are 
assured. It is a fixed income instrument. Bond holders would receive the 
specified interest income on the specified periods. The principal amount will 
be returned at the time of maturity. The government bonds are categorized 
based on the tenure of the bonds 
 
Government Bills: Bonds with maturity period of less than one year. 
Government Notes: Bonds with maturity period of  one year to ten years. 
Government Bonds: Bonds with maturity period of more than ten years. 
 
Sovereign Bonds 
I hope now you have understood the government bonds. As I have mentioned in 
the above section, government bonds are issued in the local currency. The 
main difference between government bonds and sovereign bonds are the 
issuing currency. Sovereign bonds are issued in the international currency and 
it can be sold to the other countries and foreign investors. It is very common 
that when a country needs huge capital to support the spending, it can borrow 
money from other countries by issuing the sovereign bonds. It has to pay the 
interest money on specific period and principal amount on the maturity period. 
 
Now you  must have got the basic idea on the sovereign debt by reading the 
above section about sovereign bonds. Sovereign debt is bonds sold to other 
countries or money borrowed from outside (it is equivalent of borrowing 
money from other countries or public) to meet the country’s spending. It has to 
be repaid on the maturity and will have to pay the interest for that borrowings. 
 This will grow by size if a country can not increase the income from taxes 
because of economic growth is very slow. 
 
Countries Facing the Sovereign Debt Problem: 
 
Euro zone under the immense pressure of handling the huge deficits and the 
debts on their portfolio. The reality is that not only the Europe has the 
problem, it is almost every developed nations has the problem after the huge 
spending on 2008 economy crisis. Europe is just the beginning, there are many 
more surprises to come in the future from big economies like USA, Japan,UK, 
etc. 
 
Ways to Solve the Debt Crisis: 
 
Every problem has a solution for it. But, the real problem is how much difficult 
to implement the plan to reduce the debt crisis. They have to increase the 
entire economy growth rate (GDP) to reduce the debt burden. It involved lot of 
monetary measures and changes on that. Central banks in all the countries 
have the huge responsibility to accelerate the economic growth. 
 
The following are the six ways to reduce the burden​ :- 
A higher growth rate of GDP. 
A lower interest rate on the public debt. 
A bailout, meaning either a current transfer payment or a capital transfer from 
abroad. 
Fiscal pain, meaning an increase in taxes and/or a cut in public spending. 
Increased recourse to seignior age (revenues from monetary issuance) by 
Central Bank. 
Default, including every form of non-compliance with the original terms of the 
debt contract, including repudiation, standstill, moratorium, restructuring, 
rescheduling of interest or principal repayment etc., 
 
16  Sovereign Debt Vs Budget Deficit? 
 
Often these two terms confused among people. Budget deficit is the difference 
between total spending and the total revenue from taxes and any other 
sources. While saying spending, we need to include the interest payment for 
the debt outstanding with other countries and public. 
 
In order to meet the spending, government will have to borrow money from 
outsiders and fill the gap on budget deficit. 
 
Accumulated budget deficit will be converted as the Sovereign Debt when the 
Country started borrowing money from the other countries. That is the reason 
it is good to maintain the minimum level of budget deficit every year.  
 
Budget deficit is denominated in the percentage of Gross Deomestic 
Product[GDP]. 
 Most of the countries in the Europe has huge budget deficit . The sad news is 
that huge economies like USA and JAPAN leading the deficit crisis. They have 
daunting task ahead to solve the problems and avoid double dip recession in 
the near future 
17  FDI or FII ? 
 
FDI OR FII, Explain what is FDI and FII in brief? 
 
Both Foreign Direct Investment [FDI] and Foreign Institutional Investment [FII] 
are Capital inflows, which are playing an important role in the rise of a 
developing country like India. FDI flows into a company’s coffers and, 
therefore, fuels production, employment, taxes and growth, whereas FII flows 
into the secondary market, i.e. stock exchanges. While both are important, 
FDI has a special importance for a country such as India. The entry of FIIs, has 
added depth and substance to the share market.  
 
Explain in detail about FDI ? 
 
Generally speaking FDI refers to capital inflows from abroad that gets invested 
in the production capacity of the economy and are ‘usually preferred over 
other forms of external finance because they are non-debt creating , 
non-volatile and their returns depend on the performance of the projects 
financed by the investors. FDI also facilitates international trade and transfer 
of knowledge, skills and technology. 
It is furthermore described as a source of economic development, 
modernisation, and employment generation, whereby the overall benefits 
(dependant on the policies of the host government) triggers technology 
spillovers, assists human capital formation, contributes to international trade 
integration and particularly exports, helps create a more competitive business 
environment, enhances enterprise development, increases total factor 
productivity and, more generally improves the efficiency of resource use. 
Attracting foreign direct investment has become an integral part of the 
economic development strategies for India. 
 
Explain what are the arguments for & against of FDI in India? 
 
Arguments for encouraging FDI 
 
Economic Growth: This is one of the major sectors, which is enormously 
benefitted from foreign direct investment. A remarkable inflow of FDI in 
various industrial units in India has boosted the economic life of country. 
Trade: FDI has opened a wide spectrum of opportunities in the trading of 
goods and services in India both in terms of import and export production. 
Products of superior quality are manufactured by various industries in India 
due to greater amount of FDI inflows in the country. 
Employment and Skill levels: FDI has also ensured a number of employment 
opportunities by aiding the setting up of industrial units in various corners of 
India.  
Technology diffusion and knowledge transfer: FDI apparently helps in the 
outsourcing of knowledge from India especially in the Information Technology 
sector. It helps in developing the know how process in India in terms of 
enhancing the technological advancement in India. 
Linkages and spillover to domestic firms: Various foreign firms are now 
occupying a position in the Indian market through joint ventures and 
collaboration concerns. The maximum amount of the profits gained by the 
foreign firms through these joint ventures is spent on the Indian market. 
 
Arguments against FDI. 
 
India has become a downpour and in the process, shown the Indian investor the 
door in both investments and in the consumption theme. 
FDI money today is twice the amount of money companies have managed to 
raise from the markets. This indicates that the average Indian investor is not 
getting any play. 
FDI inflows into India may be marginal when compared to what China is seeing, 
but there is no denying that the $37 billion of FDI inflow in FY 2010 is nine 
times what came into the country in 2000. Cumulative FDI stands so far at 
$166 billion – that is twice the amount of FIIs inflows. And if FDI is taken at 
market value, it works out to USD 400 billion dollars – again, two times the 
total FII holdings in India. 
 
The balance between FDI and FII has become lop-sided in FDI’s favour. Over 
85% of the four wheeler sector, over 80% of the consumer durables space, and 
over 25% of the Cement sector is occupied by FDI money. That’s not all. The 
amount of FDI participation is rising steadily at both the project and the 
subsidiary level in the real estate and capital goods sectors. Not to mention 
higher in-bound acquisitions in mining, metals and pharmaceuticals. 
 
Explain in detail about FII investments in India? 
 
FIIs refers to entities (banks, insurance companies, mutual funds etc) 
registered in a country other than in which they are investing. For exp a US 
Mutual Fund which invests in the Indian Stock Market. FIIs usually pool large 
sums of money and invest those in securities, real property and other 
investment assets. As bulk of their investments are in the stock market, they 
affect the stock market movement significantly. 
 
Explain what are the arguments FOR and AGAINST -- FII investments? 
 
ARGUMENTS FOR – FIIs 
 
FIIs inflows augment the sources of funds in the Indian capital markets. FIIs 
investment reduces the required rate of return for equity, enhances stock 
prices, and fosters investment by Indian firms in the country. 
 
FIIs in India can improve market efficiency through two channels. First, when 
adverse macroeconomic news, such as a bad monsoon, unsettles many 
domestic investors, it may be easier for a globally diversified portfolio manger 
to be more dispassionate about India’s prospects, and engage in stabilizing 
trades. 
Second, at the level of individual stocks and industries, FIIs may act as a 
channel through which knowledge and ideas about valuation of a firm or an 
industry can more rapidly propagate into India. For example, foreign investors 
were able to rapidly assess the potential of firms like Infosys, which are 
primarily export-oriented, applying valuation principles that prevailed outside 
for software services companies. 
The activities of international institutional investors help strengthen Indian 
finance. FIIs advocate ideas in market design, promote innovation, 
development of sophisticated products in financial intermediation, and lead to 
spillovers of human capital by exposing Indian participation to modern financial 
techniques, and international best practices sand systems.  
Like any other investors, FIIs are on the lookout for investment opportunities, 
which could give them better rates of return. With this being the prime focus, 
emerging markets like India, China, Brazil etc., have caught their eye over the 
last few years. These countries have been growing at a greater pace than 
other developed countries and subsequently offer better opportunities for the 
FIIs. 
With one of the highest GDP growth rates over the last few years, India has also 
experienced one of the highest net FII inflows in the world. Other than the 
growth prospects there are other important parameters like political 
environment, laws, liquidity of their investment etc.,  
Apart from the money that is brought in, FII investment is a testament of 
increasing global investor confidence in a particular economy and stock 
market. For a Country like India this money brought in by the FIIs adds to the 
foreign reserves which can be used to import oil, machinery etc.,  
FIIs always purchase stocks on the basis of fundamental. This means that it is 
essential to have information to evaluate, so research becomes important and 
this leads to increasing demands on companies to become more transparent 
and more disclosures. 
The increasing presence of this class of investors leads to reform of securities 
trading and transaction systems, nurturing of securities brokers and liquid 
markets.  
 
ARGUMENTS AGAINST FIIs INVESTMENT 
 
But as oppose to FII, the FDI in manufacturing, infrastructure etc., leads to the 
creation of assets, which will remain within the territorial boundaries of the 
country even if the foreign investor wishes to withdraw from the company. 
The foreign capital is free and unpredictable and is always on the look out of 
profits. FIIs frequently move investments, and those swings can be expected 
to bring severe price fluctuations resulting in increasing volatility. 
The FII investment flows only into the secondary market. It helps in increasing 
capital availability in general rather than enhancing the capital of a specific 
enterprise. 
 
CONCLUSION 
The new economic policy regime in India, which came into being in mid 1991, 
emphasized the role that foreign capital can play in furthering the country’s 
development aspirations, in particular her industrialization needs. In so doing, 
a two-pronged strategy was adopted one to attract FDI which is seen, in 
addition to capital, as a bundle of assets like technology, skills, management 
techniques, access to foreign markets, etc, and two, to encourage portfolio 
capital flows which help develop capital markets and case the financing 
constrains of Indian enterprises. The FDI policy was liberalized gradually in 
terms of the eligible sectors, extent of foreign participation and the need for 
case by ca se approvals. The expectations from the two types of flows were 
quite different.  
The Govt faces a challenge of managing the periodic surge in capital flows that 
could lead to problem of absorptive capacity in the economy, fuelling asset 
price bubbles, currency appreciation and stoking inflation. 
Govt feels that it is necessary to focus on the quality of capital inflows with 
greater emphasis on attracting long-term components, including FDI, so as to 
enhance the sustainability of the balance of payments (BOP) over the medium 
term. 
Economists say that as a rule of thumb, developing nations stand more to gain 
through FDI, which is why as the WTO developed nations are driving the 
developing ones hard. China, for example, could become a big exporter only 
after wooing and getting FDI. Indeed FDI has multiplier effects – foreign 
exchange, employment, infrastructure, etc., all get a boost in its wake. 
In fact, FDI in manufacturing, infrastructure and other sectors is far better than 
commercial borrowing or investment in scripts by FIIs. 
 
The investments by FIIs could be considered as Hot Money, which can be 
withdrawn by them at any time depending upon their judgement of the 
economic scene. The recent sharp dip in the stock market can be attributed to 
the FIIs perception that India will not be able to handle inflation.  
FIIs frequently move investments, and those swings can be expected to bring 
severe price fluctuations resulting in increasing volatility. Further, the FII 
investment flows only into the secondary market. It helps in increasing capital 
availability in general rather than enhancing the capital of a specific 
enterprise. Hence, it is generally felt that FDI is better than investment by 
FIIs. 
 
At the moment, both India and China are enjoying relatively high growth rates. 
This has particularly attracted the attention of foreign investors, who wish to 
set up manufacturing bases in India or invest in the service sector. Thus, it is 
time that we have a clear cut FDI policy, which covers all the sectors of the 
economy except those where states feels that there shouldn’t be foreign 
investment as in the case of atomic power. 
  
At the moment, there is no single policy on FDI, instead some sort of adhocism. 
The  
Cap on FDI varies from sector to sector, whereas there is an automatic 
approval in other cases, where foreign equity participation is up to 51%. In 
certain areas such as real estate no FDI is allowed. 
 
Moreover, foreign companies are not as yet allowed to take over sick 
companies. There are a number of these in the textile, bicycle-manufacturing 
sectors or there are individual PSUs like pharmaceuticals and photo films which 
could be taken over by foreign companies being in new technology and 
management system, but can turn them into profitable units. 
It may be mentioned that not only the developing countries but also the 
developed countries are looking for opportunities to increase inflow of FDI. A 
study conducted by FICCI recently stated that countries such as Germany and 
France still allow investment allowance or accelerated depreciation to foreign 
direct investors. China grants 10 year tax incentive to promote firms engaged 
in infrastructure, energy sector and knowledge industry. South Korea provides 
special incentives for capital investments. Countries like Netherlands, 
Denmark, Belgium, Spain, Switzerland, Luxembourg provide tax incentives, 
they follow the concept of group taxation. 
If India encourages FDI it won’t be unusual or against its own interest. In the 
Current context, FDI would mean creation of assets, more jobs and a 
competitive economy; it is also likely to contribute significantly to the 
exchequer in the form of direct and indirect taxes. A good monsoon coupled 
with realistic FDI policy can sustain the now floundering high growth rate, 
which we were able to achieve with much difficulty in these past few years. 
[ L V R Prasad, Canara Bank working in Treasury and international operations 
wing ]. 
 
 
18  What is CURRENCY WAR ? VV. IMP. 
 
IMF Managing Director Dominique Strauss-Khan used the term ‘Currency War’ 
during the recent annual meeting of IMF and WB while addressing the issue of 
containing an escalating currency dispute that has threatened to undermine 
global cooperation on economic recovery.  
 
[The phenomenon of competitive devaluation of currencies by different 
nations to boost competitiveness of exports was described as the “Internal 
Currency War” for the first time by Brazil’s Finance Mister, Guido Mantega in 
Sao Paulo on Sep, 27th, 2010. His comments followed a series of interventions 
by Central Banks in Japan, South Korea and Taiwan in an effort to make heir 
currencies cheaper. This was over and above a continuous suppression of 
Yuan by China – a powerhouse of exports, in spite of strong pressures from the 
US to allow it to rise.] 
 
China as “Currency manipulator” a comment by President Obama during his 
early days in Office. The high jobless rate (nearly 10%) in United States and 
other Western countries along with some emerging economies in the world has 
prompted to believe that China is deliberately manipulating its Currency YAN 
by not allowing it to appreciate. Critics are arguing that YUAN is undervalued 
by as much as 40%. So the ;major global forces have intensified their calls for 
China to allow its currency to appreciate in the hope that it will increase 
American and other western Country’s export and help create jobs at home.  
 
On the other hand China has refused to bow down to such pressure – accusing 
the developed nations particularly United States that the enormous bailout 
packages paid to failed banks have resulted in multiplication of their national 
and international debt, which in turn caused debt crisis and the loss of 
confidence among market players of their capacity to repay their debts. China 
also accused them of keeping their interest rates almost near to zero and 
policy of “PRINTING MONEY” (through quantitative easing) as main cause of 
Currency dispute adding to the economic woes of the developed countries.  
 
China’s argument behind rejection of rapid revaluation of its currency is that 
it is basically a developing country with per capita income lower than that of 
several crises ridden European countries including Greece. So China fears that 
drastic appreciation of Yuan will jeopardize their own domestic economy and 
would mean a shock therapy which China can’t withstand as it would slow 
down economic growth of China causing unemployment leading to possible 
social discontent. It has instead proposed gradual appreciation of its Currency 
without any binding timeliness. 
Economists and some policy makers have warned of the dangers of a Currency 
War in which nations weaken the value of their own currencies to better 
compete with China on the world market. Slow growth in Europe and the 
United States has led to a surge of capital inflow into faster growing economies 
like India, Mexico and South Korea putting upward pressure on their 
currencies. Japan, Brazil and other countries have already tried to limit 
currency appreciation by introducing or enhancing taxes on foreign capital 
investment in their market.  
 
DEFINITION OF CURRENCY WAR: Xinhua, the Chinese news agency defines 
Currency War as ‘ the situation where one nation, relying on its economic 
power, buffets its competitors and seizes other nations’ wealth through 
monetary and foreign exchange policies. It is a form of economic warfare with 
cold premeditation, specific purpose and considerable destructive power.  
 
Economists opine that currency war can be better termed “Competitive 
Devaluation”, where competing countries try to weaken their exchange rates 
so as to protect their domestic economy and preserve jobs and growth at 
home. Economists all over the world are comparing the 2010 outbreak of 
competitive devaluation with widely recognized episode of currency war that 
occurred in the 1930s when all participants suffered unpredictable changes in 
exchange rates, reducing international trade as a consequence. 
 
DEVALUATION OF CURRENCY AND ITS EFFECT:  
When a country suffers from high unemployment rate or wishes to follow policy 
of Export led growth of its economy, it tries to weaken its currency, as a 
weaker currency raises the cost of import while reducing the prices of goods 
exported by it in the international market, thereby creating demand for the 
same. This encourages increased domestic production creating newer jobs as 
well as GDP growth. An emerging economy may also follow devaluation to 
build up foreign exchange reserve to protect them against any future financial 
crises.  
 
However, currency devaluation has several adverse consequences for a 
country. 
It may lower the standard of living of citizens by lowering their purchasing 
power (as imports gets costlier) and can also push up inflation.   
Devaluation can also make international debt servicing more expensive if the 
debts are denominated in Foreign currency.   
It can also discourage foreign investments as devaluation is generally seen as a 
sign of weak governance.  
 
MECHANISM FOR DEVALUATION 
A Country’s exchange rate is essentially set by the market forces. However, 
the Central Bank of a country can intervene in the market to effect devaluation 
by increasing the supply of its currency to buy other currencies, thereby 
causing fall in the value of its own currency. Another way of devaluing home 
currency is quantitative easing which has become common in 2009 and 2010. 
In quantitative easing, the Central Bank of the country increases the money 
supply by purchasing government securities from banks. This increased money 
supply leads to lowering of interest rates in the economy, thereby weakening 
the external value of its currency. 
The third method of devaluation is to talk down the value of home currency by 
giving hint of a future action thereby discouraging speculators from taking any 
position on the hope of a future rise of the currency. 
 
QUANTITATIVE EASING 
Quantitative easing is the process of infusing money into the system by 
creating ‘new money’ and eventually buying financial assets like bonds and 
corporate debt from financial institutions in the country. This is done by 
Central Banks through what is popularly known as open market operations. 
The idea is to provide adequate money in the system thereby lowering interest 
rates to spur consumption demand in the economy. There is a implicit promise 
to withdraw the newly created money once the economy improves, so as to 
avoid inflation. Quantitative easing was widely used as a response to the 
financial crisis that began in 2007-08, especially by US, Japan, UK and to a 
lesser extent the Eurozone. 
 
Quantitative easing devalues a country’s currency in two different ways. It 
encourages speculators to anticipate the possible decline in the value of the 
currency. Secondly, the large supply of home currency lowers domestic 
interest rate in comparison to interest rates of other countries where 
quantitative easing is not being practiced. This will increase the Capital flow 
of the devalued currency into the country with higher interest rate in order to 
earn more on investment and trade causing appreciation of other country’s 
currency. Thus the recipient country’s exports will be hit and with 
appreciated exchange rate, its import from the country implementing 
quantitative easing will increase thereby creating imbalance.  
 
WHAT ARE THE CONDITONS OF CURRENCY WAR....? 
For an international Currency war, a large number of significant economies 
must wish to devalue their currencies at the same time. In absence of any 
agreed global exchange rate system, each country would act independently and 
a Currency war may be triggered.  
 
HISTORY OF CURRENCY WAR 
 
Till 1930 
Till 18th Century, the world trade was not significant and hence exchange rats 
were not a matter of great concern. In this period, devaluation was adopted to 
increase money supply rather than helping county’s exports and to finance 
wars or pay debts. The notable devaluation in this period was during 
Napoleonic wars. After the World War I, many countries other than US 
experienced recession as they immediately returned to the gold standard. 
However currency war did not occur as the then world’s largest economy 
Great Britain tried to raise it’s currency value to its pre-war levels. So there 
was no competitive devaluation till 1930. 
 
GREAT DEPRESSION OF 1930: 
At the time of great depression in 1930, most of the Countries abandoned the 
gold standard thus resulting in currencies not having any intrinsic value. 
Devaluation become common as unemployment rates rose and every economy 
tried to gain advantage of devaluation. The result of competitive devaluation 
was sharp decline in global trade thereby hurting all economies. The currency 
war of 1930s is generally considered to have began when in 1931, Great 
Britain abandoned gold standard. 
 
From 1940 to 1971 
The period in global economy is better known as Bretton Woods era, where in 
1944 under an international agreement, the US pledged to redeem $35 for an 
ounce of Gold. This semi fixed exchanged rate did not give any option for 
competitive devaluation. Again global growth during this period was very high 
with very little scope or incentive for the major economies to devalue their 
currencies.  
 
AFTER 1971 to 2000 
In 1971, after following expansionary monetary policy with inflation leading to 
overvaluation of US dollar, US Government refused to honour their 
commitment under Bretton Woods agreement to exchange an ounce of gold for 
$35 and asked various central banks to cooperate by buying and keeping dollar 
reserves. With this the golden era of Bretton Woods ended. In the mid 
eighties, Plaza accord was signed between the industrialized nations like 
France, Germany, Japan and the US when they agreed for depreciation of US 
dollar in relation to Japanese Yen and the German Deutschemark. With rise to 
more free market influences on the exchange rate system during 1990s, most 
of the countries left their currencies to market forces and did not intervene 
even to correct substantial current account deficit. 
 
AFTER 2000 to 2008 
During 1997 Asian financial crisis, Several Asian economies ran critically low on 
foreign reserves and had to accept IMF’s harsh conditions of forced sale of 
their assets. This caused loss of faith in so called free market and from 2000 
onwards, both developing and emerging economies started intervening to keep 
value of their currencies low to adopt export led growth strategy and to build 
up foreign exchange reserves to protect themselves in case of any future 
shocks. However no currency war resulted as almost all advanced economies 
accepted this strategy. This enabled the citizens of those countries to buy 
cheap goods and enjoy higher standard of living. 
 
AFTER 2009 
With severe economic downturn due to global financial crisis in 2008 and with 
global trade declining by 12% by 2009, most countries including developed and 
emerging economies desired to lower their exchange rate causing the 
conditions required for a currency war. In 2010, Bank of Japan started 
suppressing the Yen to aid exports. America and other advanced nations that 
had not intervened earlier, also started devaluing their currencies to keep jobs 
from going to the emerging economies via BPOs and for export advantage. 
China, India and other emerging economies anyway have undervalued 
currencies vis-a-vis their purchase power parity (PPP) levels. 
THUS by 2010, all countries have entered into a race of keeping their currency 
value to the bottom with possible zero-sum game with no winners. This 
situation made IMF Managing Director to warn the world of a possible currency 
war. 
 
CHINA 
With its huge current account surplus and nearly $3 trillion of foreign exchange 
reserves. China has often been singled out by US and other advanced 
economies for keeping the value of its currency artificially low and thereby not 
allowing global trade to improve. However, China’s export led growth model 
is not a new phenomenon and according to its government: any sharp 
appreciation of its currency will lead to rapid unemployment and social unrest. 
China has cited Japan’s experience in agreeing to Plaza accord allowing its 
Currency Yen to appreciate substantially against dollar and falling to long 
period of economic stagnation. China has blamed US administration’s failure 
to control their bankers and causing financial crisis in 2008. However China 
has agreed for gradual correction of its currency value and so far increased its 
rate of interest twice in 2010. So far China has refused to cede to the IMF and 
other advanced countries pressure to allow sharp appreciation of its currency. 
 
JAPAN 
Japan has also large current account surplus and in 2009 and 2010 have 
allowed Yen to appreciate. However in Sept, 2010, Japan has intervened 
twice to effect devaluation in Yen. With an aging population, high public debt 
and vulnerability to deflation, Japan has a limitation to the possible 
devaluation of its currency. 
 
EUROZONE 
In Eurozone, while Germany has large current account surplus, countries like 
Greece, Spain, Portugal, Ireland have current account deficit. So while 
Germany can accept or even benefit from currency appreciation, other 
countries in Eurozone are likely to benefit from depreciation. In 2009, ECB did 
practice quantitative easing but to a lesser extent than US and UK. In 2010, 
there was intervention in the value of the Euro but most of the reason for 
appreciation of Euro was due to China’s purchase of Euro denominated bonds. 
  
LATIN AMERICA 
Brazil, the largest economy in the region, has largely allowed their currency to 
float freely. However in October, 2010 Brazil doubled tax on foreign capital, 
to discourage huge inflow of foreign capital. Some other countries in the 
region like Chile have decided to implement capital controls to curb gain in 
their currency peso. Colombia and Costa Rica has initiated programmes to buy 
Dollars to check their currency appreciation 
 
INDIA 
So far Indian Rupee has appreciated little over 5% against US Dollar. India has 
traditionally run a current account deficit and has so far not intervened to 
match the current account deficit by foreign capital inflows. India’s reserve 
position is comfortable with nearly $300 billion in foreign exchange reserves. 
With the second round of quantitative easing by US Federal Reserve, India is 
likely to see a gush of capital inflows, which is likely to push up the stock 
prices. RBI Governor has stated historically India has never tried to build up 
reserves and has opined that economies that have current account surpluses or 
only small deficits have so far intervened. However if the inflows become 
lumpy and volatile or they disrupt the macro-economic situation, then RBI will 
intervene. 
 
REST OF ASIA 
Most Asian currencies are appreciating against Dollar with a surge in inflows in 
thee economies. Among them Malaysia & Thailand have been the highest 
appreciation of their currencies to the extent of 9.5% against Dollar and other 
countries like Philippines nearly 6%, Singapore 6%, Indonesia over 5% with 
China the lowest 2% rise in Yuan against Dollar. 
 
SOLUTION TO CURRENCY WAR 
While some economists are in favour of QE II by US for early recovery of the US 
economy and IMF supports the same, some economists are sceptical about the 
effect of QEII by US. They are of the opinion that it may increase the 
possibility of currency war as in the process may lead to inflation. Questions 
have been raised about the sustainability China and Japan’s appetite for US 
T-bills and financing of US deficit? 
 
Appreciation of the currencies of the emerging economies would lead to fall in 
export competitiveness and loss of jobs and therefore would not be a desired 
outcome for these economies. 
To reduce the chances of a currency war, IMF with its independent identity 
and strong expertise, has to encourage G20 countries to co-operate among 
themselves. One of the suggestions to let the top three or four currencies 
having significant role in the global trade be “fixed”. And if there is need for 
adjustment to reflect major changes in global trade, this is to be done only 
after discussion among its members. For the rest, currencies may be pegged 
or be floating as a particular country may decide. Another suggestion is to find 
out the possibility of replacing the traditional reserve currencies with IMF’s 
SDR (Special Drawing Rights). 
 
Whatever may be the outcome in dialogues among the countries to end 
possible currency war, it’s a long road to find out a suitable solution unless the 
major economies have an open mind to the problems of emerging economies 
and allow them to put forth their say. So far world finance leaders have failed 
to find a suitable solution to the ongoing currency dispute as China has not 
bowed down to the mounting pressures of the world leaders to take drastic 
measures in correcting its currency value. The South Africa’s Finance Minister 
has rightly appealed to G20 finance ministers to put the interests of the global 
economy ahead of those of their national economy during deliberations else 
global tensions will further rise over currency rates as emerging markets try to 
fend off a flood of investment funds seeking higher returns and countries 
scramble to keep the prices of their exports competitive leading to a Virtual 
Trade War. 
[By Arun Kumar Ghosh, Senior Manager, Forex, Bank of Maharastra] CAB – 
Jan-March 2011