Current International Financial Systems

Team 4 Satheash(11AB33) Sripriya(11AA38) Swathi(11AA42) Christopher(10AC10)

International Financial Systems An introduction

The global financial system (GFS) is the financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level. The main players: Global institutions such as International Monetary Fund and Bank for International Settlements National agencies and government departments Private institutions acting on the global scale and Regional institutions, e.g., the Eurozone.

International Financial Systems An introduction The most prominent international institutions are the
IMF, the World Bank and the WTO The International Monetary Fund Keeps account of international balance of payments accounts of member states. The IMF acts as a lender of last resort for members in financial distress, e.g., currency crisis, problems meeting balance of payment when in deficit and debt default. Membership is based on quotas, or the amount of money a country provides to the fund relative to the size of its role in the international trading system.

International Financial Systems

The World Bank aims to provide funding, take up credit risk or offer favorable terms to development projects mostly in developing countries that couldn't be obtained by the private sector. The World Trade Organization settles trade disputes and negotiates international trade agreements in its rounds of talks. Also important is the Bank for International Settlements, the intergovernmental organization for central banks worldwide. It has two subsidiary bodies: The Basel Committee on Banking Supervision The Financial Stability Board.

World Bank - Organizations

The International Bank for Reconstruction and Development (IBRD) lends to governments of middle-income and creditworthy low-income countries The International Development Association (IDA) provides interest-free loanscalled credits and grants to governments of the poorest countries

The International Finance Corporation(IFC) provides loans, equity and technical assistance to stimulate private sector investment in developing countries.

World Bank - Organizations

The Multilateral Investment Guarantee Agency (MIGA) provides guarantees against losses caused by non-commercial risks to investors in developing countries.

The International Centre for Settlement of Investment Disputes (ICSID) provides international facilities for conciliation and arbitration of investment disputes.

Level 1 - Classification of Exchange Rate Regimes

Pegged Intermediate

Exchange Rate Regimes

Floating

Level 2-Classification

Pegged Hard Pegs Traditional pegs

Intermediate Floats with rule-based intervention Discretionary

Floating Free Floats

Hard Pegs
Dollarization
Foreign Currency as a legal tender Seignorage to issuing country

Currency Boards

Exchange rate pegged to foreign currency Seignorage to home country

Monetary Union

Group of countries-common currencycommon regional central bank Seignorage to region

Traditional Pegs
Single Currency Peg Basket Peg
Exchange rate pegged to fixed par value to a single foreign currency

Exchange rate pegged to a basket

Floats with rule-based regimes

Co-operatible Bilateral exchange rates of companies within a pre-set regimes
range of each other Exchange rate adjusted a predetermined rate or as a function of inflation differential

Crawling peg

Target Zones Exchange rate allowed to fluctuate within a pre-set and Bands range

Floats with discretionary intervention

Managed Floating
Exchange rates move according to supply and demand

Free Floats
Independent Floating
Exchange rate determined based on daily supply and demand with minor or no official intervention

IMF Classification of Exchange Rate Regimes

Exchange arrangements with no separate legal tender
Currency board arrangements Conventional fixed peg arrangements Pegged exchange rates within horizontal bands Crawling pegs Exchange Rates within crawling bands

Managed floating with no predetermined path for the exchange rate

Independently floating

Exchange Rate and Monetary Policies

Monetary

Policy

By Central bank, currency board or a regulatory committee Determine size and rate of growth of money supply Affect interest rates

Exchange

Rate Policy

Policy of government towards level of exchange rate of currency Influenced using gold and foreign currency reserve, or interest rates (monetary policy)

Exchange Rate of the Indian Rupee

Initially linked with GBP INR 1 = 1s.6d ( s shillings, d pennies) 1 % using GBP (intervention currency) Indian Rupee devaluated in 1996

After Collapse of Bretton Woods System

INR pegged into basket of currencies on 25 Sep, 1975 A band of 2.25% on GBP/INR Devalued again in July 1991

1992 RBI Instituted LERMS (Liberalized Exchange Rate Management System)

40% of export Exchange Rate as per RBI 60% of export Market Exchange Rate

Effects from March 1, 1993

Aug 2,1993 Switched over from indirect to direct quote US Dollar as Base Currency

Devaluation

It is the reduction in the value of currency Used as a catalyst during economic crisis Thailand,Mexico,Czech republic-All devalued strongly

Types of Devaluation

Planned Devaluation

Market driven devaluation

Currency Convertibility
Ability of residents and non residents to exchange domestic currency for foreign currency without limit, whatever be the purpose of transaction.

TYPES:

Fully convertible currency Partially convertible currency Non-convertible currency

IMF concept:
Considers convertibility only for current account transaction and leaves to the country to regulate capital

CONVERTIBILITY
Current Account Convertibility

Money can be easily converted into dollar, yen, pound, rupee, etc

Capital Account Convertibilty

Money cannot be easily converted into different currency, RBI has strict guidelines

All import and exports

Invisible import and exports

Investment in securities Other investments

Capital Account

Current account

Inward private remittances Pension payments

Government Loans
Short term investments

Government grants

In India Rupee allowed to be convertible under current account.

Tarapore Commitee

Observations:
Banking system will be exposed to greater market volatility. Countries intending to move towards FCAC need to ensure well integrated market segments.

Recommendations:
Development and integration of financial markets in India. (Money market, Government securities market, Foreign exchange market)

Recommendations for FOREX market

Spot and forward market should be liberalized , removing th constraints of past performance/ underlying exposures. Forex business seperated from lending transactions and electronic trading platform. Rbis intervention in forex shall be through anonymous orde matching system FIIs provided with facility of cancellation and re-booking o forward contracts and other derivatives . Existing guaranteed settlement platform of CCIL extended to forward market Banking sector allowed to hedge currency swaps by buyin and selling without any monetary limits.

INTERNATIONAL LIQUIDITY AND INTERNATIONAL RESERVES

International liquidity:
Financial resources and facilities available to a country for financing the deficit in its balance of payments. Countrys international reserves as well as its capacity to borrow in the international market.

Components:
Gold and foreign currencies Borrowing facilities available from IMF Special drawing rights Borrowing capacity of the country in international market.

Purpose of foreign exchange reserves:

Capacity of a country to honour its international obligations (Precautionary motive) Capacity of the monetary authority to intervene in foreign exchange market. (Transaction motive) Achieve a balance between demand and supply of foreign currencies.

DEMERITS
Lack of international reserve will result in global shortage of liquidity. Vast build up reserves carries cost. Huge reserves also fuels inflation in the economy.

INDICATORS OF ADEQUECY OF FOREIGN EXCHANGE RESERVES:

Import adequecy- foreign exchange reserve = atleast 3
months of imports

Debt adequecy- payment liabilities should be taken into

account in addition to imports.

Capital adequecy- reserve adequecy measures in terms of

short term debt and portfolio stock to reserves.

Monetary adequecy- net foreign exchange assets to current

Deployment of Foreign Currency Assets

Guiding principle: Stable earnings with low risk.

Deployed as deposits with

Other Central banks Bank for International Settlements (BIS) Top rated foreign commercial banks Securities rep. debt of sovereigns. Supra-national institutions Other institutions or instruments approved by Central board of RBI

Thank You!