Industrial Finance for Merge

8/6/2019 Industrial Finance for Merge

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Question: What are the sources of industrial finance?

INDUSTRIAL FINANCE

Need for industrial finance

Finance is the life blood of industry. Adequate finance is absolutely

necessary to oil the wheels of the industrial machine, to ensure its smooth

working and to prevent its breakdown. Lack of adequate and timely finance

is one of the causes of slow development of industries of India.

Industry needs funds for block or capital expenditure, i.e. , for the

purchase of land, erection of the factory building, for installation of

machinery, etc, and in the case of a going concern, for extensions andreplacements. Besides this, funds are also required for the purchase of raw

materials, for stores, for other expenses incidental to production and

marketing, and for meeting the day- to day requirements of the industry.

This is known as the working capital.

Sources of industrial finance

There are 2 broad sources of finance: internal and external.

The internal sources mean internal funds e.g., free reserves of an

industrial concern, its depreciation funds and retained profits. The external

sources on the other hand, mean sources outside the businesses, i.e., raising

fresh capital and issuing debentures, long and short- term loans from various

sources, accepting deposits, etc.

The following are the main sources from which the Indian industry draws

finance:

Shares and debentures

The bulk of the capital is raised through the sale of share. Debentures are

also issued but till recently these accounted for a small proportion of capital

raised for industry. However, lately they have become immensely popular


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with the investors, especially the convertible debentures/bonds for e.g., in

1986-87 Rs. 1369 crores were raised through debentures out of the total

capital issues [paid up] of Rs 1774 crores in 1987-88 to Rs 3117 crores in

1988 -89 from Rs. 664 croress in 1987-88.thus, debenture issues formed

67.8 percent of the total new capital issues in 1988-89.

In recent years, however, the role of equity or share capital has

declined for 2 reasons [a] compulsive of the mixed economy that we have,

[b] progressive institutionalization of communitys savings. The term

financial institutions have now emerged as major suppliers of industrial

finance. They underwrite 92.97% of the share capital offered to the public.

Public deposits

Deposits from the public are another source. In fact, the Ahmedabad

textile industry was set up on the basis of this source. In recent years, owing

to a policy of restraints on bank credit, a large number of industrial concerns

all over the country have been inviting deposits from the public for one to

three years and paying attractive rates of interest which are much higher than

are allowed by banks on their fixed deposits. In order to protect the interest

of depositors, the RBI has imposed certain restrictions on the receipt of

deposits by companies. At the march end 1997, the deposits held by2,376

public limited companies stood Rs. 223873 crores. This method however, is

not satisfactory it is not a sound policy to finance schemes of long term

investment with short-term deposit of 1 to 3 years.

Commercial banks: short term loans, on the cash-credit system, can be

obtained by the industrial concerns from the commercial banks on the

security of stock and, in some cases, till recently, on the additional guarantee

of the managing agent.


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while the traditional policies of Indian banks contribute quite successfully

to meeting short-term needs of existing industries and merchants, their

contributions to the longer term needs of industry and requirement of

potential new industrialists have been either indirect or peripheral .

Although the commercial banks have been mostly providing self-liquidating

finance for short-term purposes, yet they have now entered the field of

medium-term finance particularly since the establishment of the industrial

development bank of India (IDBI) which provides refinance facilities to

them.

Now in India, from the time an industrialist conceives a new project;

his bank is with him always guiding and advising. His bank may underwrite

the new capital issue in part, collect the allotment and call money of

subscribed shares, furnish guarantees for deferred payment in respect of

plant and equipment to be imported, and when the project comes to fruition

provide working capital requirement to run the factory satisfactorily.

According to Reserve Bank study on 621 non- govt and non-financial large

public limited companies, short term bank borrowings as percentage of

inventories increased from 44.8% in 1984-85, to 48.2%in 1987-88.

Indigenous bankers

In urban areas especially medium sized industries, can obtain finance

from the indigenous bankers. But they charge exorbitant rates of interest

which few industries can bear. Not many industries approach the now. Since

the setting up of the state financial corporations, this source of finance is,

therefore becoming less and less important.


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Term lending institutions

In view of the inadequacy of the above mentioned source s, several

new financial institutions have been started since independence to meet the

financial requirement of the Indian industries. These are the industrial

finance corporation [IFCI], industrial credit and Investment Corporation of

India {ICICI}, industrial development bank of India [IDBI] and small

industries development bank of India [SIDBI] at the all India level and state

finance corporation[SFC], state industrial development corporation

[SIDCO] in states. Besides, UTI, LIC, general insurance companies [GIC]

etc, also provide finance for industries. With their rapidly growing scale of

operations, this term lending institutions have, in recent years, emerged as

the most important source of industrial finance of India. Aggregate

assistance sanctioned by them in 2000 stood at Rs 10, 3748.9crores.

Leasing and financial companies

A novel source of industrial finance has to late start emerging in India,

viz., leasing and finance companies. They lease costly plant and equipment

to industrial finance concerns and also sometimes sell them equipment on

hire- purchasing basis, by installing leased plant and machinery, an

industrial concern saves on fixed capital and can thus reinforce its working

capital. Lease rental being an allowable expenditure for tax purposes, is

another attractive feature of leasing. During the last 5-6 years, a large

number of leasing companies have been formed and they bid fair to emerge

as a significant source of industrial finance, as it has done in the U.S.A and

U.K. as of march 1986, 470 leasing and composite financial companies

accounted for leasing out assets worth Rs, 839 crores, according to the

information available with the reserve bank of India.


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Retained profits

So far we have mentioned the external sources of finance for industry.

There is besides an internal source, the own savings of an a industrial i.e.

industrial profits or, in other words, the profits that, instead of being,

distributed among share holders, are Ploughed back into the industry for its

replacements, modernization, Up gradation of technology, expansion and

diversification. Depreciation funds and investment allowance reserved funds

accumulated over period of time constitute other internal sources for

industrial concerns. Once an industrial concern is started and gets going, its

retained profits are an important source of finance for its further growth.

According to a recent survey of 1942 non- government non- financial public

limited companies by the reserve bank of India, the retained profits of these

companies were Rs 297 crores. However, in the case of 621 non-

government and non financial large public limited companies the profits

retained were estimated at Rs 203 crores at the march end 1987. These data

establish that at present the relative importance of retained profits is quite

low.

In recent years, the capital market has shown buoyancy as is evident

from the increasing trend of public issues of shares and debentures. The

funds raised from such issues have been increasing.

Foreign capital

Another source of industrial finance of forging capital. Foreign capital can

take the form of [a] direct private investment by foreigners in industrial

concerns,[b] collaboration of foreign business with Indian business in

starting new industrial units,[c] loans or grants by foreign governments for

industrial projects, and [d] loans by international institutions, like the world


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bank and its soft loan affiliate, the industrial development association[IDA]

for industrial enterprises.

Several old industries in India like tea, jute, mining, owe their

development to foreign enterprises and forging capital. Of course, since

independence the share of foreign capital in these industries has been

considerably reduced. But a large number of foreign collaborations have

come up in starting new industries. A substantial amount of forging capital,

particularly in the form of government loans and loans from international

instructions, has gone into the expansion of the public sector industries like

steel plants, heavy electrical, machine tools, fertilizer plants and petroleum

refining. It may be added that in order to safeguard national interested, the

government allows forging capital on a selective basis and does not follow

an open-door policy in regard to it. However, the new trade policy

announced on july4, 1991 liberalized the trade policy towards foreign

capital.

Limitations of existing industrial financing system

The system of industrial finance prevalent at present is still far from

satisfactory even though several new institutions have been started in recent

years to fill gas in the structure of industrial finance. The following are main

unsatisfactory features:

1) Inadequacy

The facilities for industrial finance are, at least have been till recently,

inadequate. In industrially advanced of countries there are industrial banks,

but there are few such banks in India. Elsewhere, there are also the issuing

houses and several special intuitions which play a very important role in

financing industries. Until recently we have no such institutions. Even


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though some new institutions have been set up in recent years, the financial

facilities continue to be inadequate.

2) Defects:

The existing sources of finance are not only inadequate, but also

suffer from very serious drawbacks. As has been mentioned already, the

deposits from the public are only fair weather friends, the managing agents

extracted a heavy price for providing finance, and the commercial banks

work on too rigid and orthodox lines to be of much use to industries. They

are usually unwilling to advance loans on personal security or on the

security of block capital, and on the other hand, insist on full backing of

easily realizable security besides, thy supply working capital only and not

block capital.

3) Costly

Not only is industrial finance inadequate it is very costly too. The

small scale and medium sized industries are seldom able to borrow from the

banks. Usually they borrow from indigenous bankers on personal security at

high very rates the banks also charge quite high rates of interests which our

industries are hardly able to bear.

4) States role insignificant

Another obvious feature of our industrial finance is the insignificant

role played by the state in this sphere. There exist, no doubt, state aid to

industries acts in all states by which the state governments advance funds for

industrial ventures. But the finance provided under these acts has been

meager. Owing to the elaborate and irksome procedure which has to be

observed for obtaining loans from the state, such loans have not been

popular.


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Foreign exchange market: is one of the important components of the

international financial system. Especially for the developing economy, the

foreign exchange market is necessary for the conversion of currencies for

short term capital flows or long term investments in the financial physical

assets of another country. The services of foreign exchange markets are

necessary not only for other financial receipts or payments between

countries involving a foreign exchange transaction.

Instruments of credit traded

In addition to conversion of forging currency notes and cash, a

number of instruments of credit are used for effecting conversion in the

foreign exchange market. These instruments are:

Telegraphic transfers [TT]

Mail transfers [MT]

Drafts & cheques

Bills of exchange.

Foreign exchange market components: there are 3 major components

in this mkt, depending upon the transaction:

1 transaction between the public and the base level;

2 transaction between the banks dealing in foreign exchange involving

conversions of currencies;

3 transaction b/w banks and central bank involving purchase and sale of

foreign currencies.

Foreign sector and foreign exchange mkt: each economy has a

foreign sector representing that economys external transactions. All such

external transactions are either economic or financial transactions. These

result in receipts into and payments out of the domestic economy. Such

receipts and payments involve the exchange of domestic currency as against


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all foreign currencies of countries with which domestic economy has

dealings. Such exchange transaction are put through in the exchange mkt for

that countrys currencies vis--vis other currencies. These national exchange

mkts are components of international financial system.

There is thus, as for any other currency, a mkt for the rupee. If an

Indian bank buys dollars, it will pay rupees for dollars & if it sells dollars, it

will receive rupees for dollars. The origin of these transactions is an or

export or an import, inward or outward remittences or any similar

transactions between Indian residents and foreign residents. An exporter in

inia receives dollars from say, USA & he surrenders the bill of exchange

along with other documents t ohis bank. Th bank would have bought that

currencies from th exporter. The bank has been since been on the look out

for selling those dollars In foreign exchange mkts for those in need of

dollars. Let us say an importer in india importing from the USA is in need of

dollars t opay to the exporters. Another bank is apporoched by the importer

with a demand for dollars and former must have sold dollars to the importer.

Having sold dollars, that bank would then buy the dollars t ocoverup their

position from the former bank.

The foreign exchange mkt in india today arose considerable more

interest than ever before. Over the past 2 years, moments changes have need

brought to bear on the exchange rate regime. This stands today as part of the

overall strategy to improve the functioning of the financial systems. The

EXIM scrip scheme which was introduced in july1991 was followed by dual

exchange rate arrangement & determine exchange rate system and the

system has worked very well. The remarkable stability of the rupee that has

attracted world wide attention.


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In the forgien exchange, the instrument of forward covered is the only

hedging product now available. The forward mkt, however, has tended to be

illiquid and virtually non existent for maturities beyond 6 months.

Historically, with the rupee depreciating steadily , exporter have been

reluctant to supply forward dollars leading to a supply demand imbalance.

This situation has changed and the forward mkt may develop depth &

liquidity in th future. Banks have been to raise currency operations from jan

1994 for their customers. These options will be on back to back basis. Banks

will not take any exposures on these transactions and will wright auctions on

a fully converted cover basis, i.e they will buy fro overseas auctions i.e

identical to the 1 sold to the customer. With the abolition of the NCNRA

scheme, the foreign exchange exchange risk on such deposits are now to be

borne by the commercial banks. The banks while attracting such deposit

will have to manage the exchange risk o n their own. The possibility of

providing credit in foreign currency to exporters is an important factor that

will be of assistance in this regard. the exchange rate of rupee in the past

15months has moved within the narrow range. The ability to operate in

foreign exchange mkt where the rates can fluatuate is something that the

banks in india need to acquire, as the Indian mkt gets more and more

intrgrated with the global financial system.

Role of reserve bank

The RBI as the central banking authority also controls the foreign currency

operations. As pound, the sterling continues to remain as a currency of

intervention, the RBI fixes the buying and selling exchange rate from time to

time based on the parity of unspecified currencies- basket of currencies

whole the RBI does not enter the foreign exchange mkt to support the Indian

rupee like bank of England.


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It buys spot and forward sterling up to 9 months forward and sells

only spot sterling thus; RBI continues to maintain external value of the

Indian rupee. Also the RBI buys major currencies like us dollars, deutsche

mkt and Japanese yen, both spot and forward up to 6 months at exchange

rates based on the previous days closing rate in the London exchange mkt

for the respective currencies.

The RBIs role in the Indian foreign exchange mkt has been more

towards guiding the banks in their exchange operations and developing the

exchange mkts by giving appropriate directive from time to time.

The RBI has so for not found it necessary to operate directly in the

foreign exchange mkt with a view stabilizing the external value of the India

rupee.

While at present it may not been felt necessary for the RBI to be

operating in the foreign exchange mkt directly. It will be seen that under the

present system. There is a possibility of the currencies enumerated above

being dumped in to the hands of RBI, when these are weak in the

international mkts. To plug this loophole, it may be advantageous for the

apex bank to intervene from time to time to support Indian rupee. However,

one has to bear in mind the expertise required for this operation and present

functions of RBI, which are very onerous compare to the function similar

institutions in other countries. Hence the question of RBIs direct operations

in the exchange mkts may not be viewed with favour in a country like ours.

However, with the increasing reserves and growing international trade, it

will not be out of place to suggest that the RBI should vocationally intervene

with a view to regulating the mkt and to maintaining the external [overseas]

value of Indian rupee.


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The central banking authority in india, that is the RBI, should also play

apostive role in deloping mkts by entering the exchange mkts at all centers

from time to time.

Feasibility of decentralization of foreign exchange bank: the recent edition

of the exchange control manual contains specific relaxations to activise and

decentralize exchange mkts in India. This emerges to be clearly indicative

of the importance monetary authorities attach to the subject of development

of exchange mkts in India, but it is doubtful wherever these measures alone

will achieve the desired objective. The exchange mkts in india, although

evolved over a period of time, still continue to be a relic of fixed rate system

totally unrealistic in the context of floating rate system, since foreign

exchange mkt is fast becoming international in nature without the time zone

differences, there is a greater need to look at the entire system, practices and

procedures obtaining the latest mkt informations in india to revive the mkts

wherever possible. Multiplicity of exchange mkts appears to be the answer

to the present day floating rate system. Exchange mkts in India have so far

tended to develop only in Mumbai & Calcutta with even new Delhi &

Chennai serving as secondary mkts. This situation needs to be rectified

keeping in mind the size of our country.

The govt has maintained the role of sterling as an intervention currency and

the RBI announces the external value of rupee in terms of sterling based on

the basket of currencies. The merchant rats for pound sterling are

published by exchange dealers association of india based on RBI buying &

selling rates with forward purchase sterling quoted at discount. The rupee


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rates for currencies other than pound sterling are based on London closing

rates which are historical. With the emergence of the active exchange mkts

in Frankfurt, Paris, Bahrain, Singapore, & hong kong, there has emerged

considerable scope for quoting the competitive rates. There is also growing

awareness amongst exporters- importers that exchange rats quoted by banks

are not competitive as dealing spreads are still very wide. It should be

studied whether we can quote more realistic rates by changing the basis of

our quotations ending the role of sterling as an intervention currency and

allow the rupee to float in international mkts either in relation to the basket

or without. It is anticipated that the comfortable reserve position will

continue for the next 5 years and the experiment of permitting the Indian

rupee to float in the international mkts may be worthwhile.

There is also a need to examine whether the present organizational structure

of banks requires to be changed where positions are maintained either at

their head offices or at Mumbai. In view of the new environment in foreign

exchange dealing, the traditional practice of maximizing the profits by

marrying transactions under fixed exchange rate system may not be

suitable in the floating rat system when dealing spreads are very narrow. We

must accept that exchange mkts can be activiesed in small centers, only if

exporters and importers can get a competitive rate when they approach their

bankers. The rates quoted to costumers at the up-country centers are

sometimes as old as a week.

Asian clearing union: for many now, regional cooperation for benefiting

trade and payments has been a subject of serious consideration all over the

world. In the asian region, the initiative on these matters for taken by ht


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ECAFE [since renamed as economic and social council for asia &pacific ]

and as a 1st step for securing regional cooperation amongst its members, the

Asian clearing union[ASU] was established on 9th dec 1974. there are 6

member countries, viz, bangaldesh, india, iran, Nepal, Pakistan& srilanka its

head quarter are based in Tehran. The clearing operations under the

arrangement commenced on the 1st nov 1975, ACU was set up with the

objective of-

1] facilitating payments for current international transactions within the

ECAFE region on a multilateral basis

2] reducing the use of extra regional reserve currencies to settle such

transactions by promoting the use of the participants currencies or AMU,

3] effecting thereby economies in he use of foreign exchange and a

reduction in the cost of marketing payments for such transactions and;

4] contributing to the expansion of trade and promotion of monetary

cooperation among the countries of the area.

Asain currency unit: the term asian currency unit refres to the deposits

placed with banks in singpore which are specially licensed by the monetary

authority of singpore to operate in the asian dollars mkt. the deposits are

usually non resident US. dollar deposits but deposits in deutsche marks, duct

h gulider, swiss francs and Japanese yen are also transacted.

The mkt for ACU has grown up fast, making singpore a prominent world

financial centre. Singpores geographical location [which gives it access to

both asian and European mkts same day], a liberal monetary policy and


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wide range of international banking facilities have helped that centre to gain

this position. The monetary authority of Singapore have recently

commenced issuing licenses to the foreign banks t oexclusively operate as

offshore units; dealing in the inter bank asian dollar mkt. this step is likey

to induce further development of the asian dollar mkt.

The secondary mkts: in addition to the traditional short term money mkt in

which the discount houses are prominent , secondary money mkts have

developed in short term funds, in both sterling aand other currencies.

The secondary sterling mkts are mainly in inter bank deposits, deposits

with local authorities and finance houses, and inter- company loans. The

other currency or eurocurrency mkts are mainly in deposits from overseas

residents, in ter- banks deposits and dollar certificates of deposit, the

merchant banks, british overseas banks, foreign banks and [since stp 1971]

the clearing banks are peominient in most of these mkts, and the discount

houses provide a secondary mkt in sterling and dollars certificates of

deposit; several north American dealers particioate also in a secondary mkt

in the dollars certificate of deposit.

These activities gained impetus during the 1950s as britian and other

countries removed official resticitions on the flow of short term funds.

Transations were encouraged by the granting of the convertibility to

external current sterling dec 1958, and since then such funds have been free

to move from abroad into the various London short term money mkts or out

again In resopnse to the level of interest rates and other factors at home and

aboard.

The domestic demand for funds has come fro m3 groups of borrowers: the

loca lauthorites , which were required from 1955 t oobtai na larger


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proporatio nof their funds from private sources; the hre- purchase finance

houses, which have also obtained a substaional part of their funds by

borrowing at short term; and industrial & Commercial companies especially

during periods of credit restrictions at home.

Local authority temporary finance

The financial needs of the local authorities in Britain greatly stimulated the

growth of the parallel money markets. The local authorities total

outstanding debt in march 1974 was $21,721 million (including $6,501

million from the central govt) , of which their temporary debt (that is, debt

repayable within 12 months) amounted to over $3500 million the temporary

debt of the local authorities was reported to be raised mainly from the banks

( by overdrafts and more especially by temporary loans through the inter

bank market), other financial institutions and industrial commercial

companies. A limited amount was also likely to be raised through the issue

of revenue bills. Specially at times of high interest rates, the local authorities

have turned towards borrowings. The bigger authorities are in daily contact

with the money market. The instrument of borrowings is a deposit receipt in

amounts normally of $50,000and upwards. the majority of the loans are

repayable at either 2 years or sevens days notice from the leader or

borrower, htough some are initially for a longer period, such as 3 months.

Merchant & overseas banks and industrial and commercial companies are all

prominent in the mkt.

Deposits with finance houses: the mkt for deposits with finance houses is

perhaps the smallest of the parallel mkts and it has contracted further since 6

of the houses obtained recognition as banks b/w Jan 1972 and Jan 1973.. in


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general, finance houses provide installments credit and leasing finance,

obtaining the funds they require from banks loans, discounted bills and

deposits. At the end of march 1974, their liabilities totaled $1,079million, of

which the major items were; deposits $445 million , bills discounted with

British banks and discount houses-$176million and other net borrowing

from banks- $160 million.

Authorized banks: to deal in foreign exchange in ht UK, banks must be duly

authorized by the treasury on the recommendation of the bank of England.

Currently, there are some 224 authorized banks, although with the opening

of branches and subsidies of foreign banks in London foreign and various

consortium banks, this number is constantly increasing. These banks

generally deal with other banks in London through the medium of brokers.

For a brokerage firm to operate in the London foreign exchange market,

membership of the foreign exchange and currency brokers association

(FECDBA) is obligatory, and moreover the firm must be specifically

authorized by the association to provide brokerage service. Banks are free to

deal directly with other banks overseas, and do so by means of telephone or

telax while dealings through banks within Britain are generally conducted by

direct telephone lines.

The euro currency mkt: is an a international mkt which was initially based

on US dollars held in Europe, but now also involves banks outside Europe

and includes leading western European currencies. The banks making up he

mkt are located mainly in Europe: in London, british and the british offices

of overseas, banks are active. In recent yrs, an important share of the euro


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currency business has been taken by the transactions in some of the major

west European currencies notably in Deutsche marks and Swiss francs.

Operations of currency exchange markets : settlement of international trade

markets usually takes place in denominated currencies which are well

accepted by international trading community, in the process, currencies are

traded. For example if UK exporters sells goods to the German , he may

want payment in pounds, and for this the importer have to secure the pounds

buy exchanging it with the DM. this nessitates the existence of the foreign

exchange market which will reflect the intractions b/w th suppliers and the

demand for currencies. Currency exchange markets functions thro

suphisticated network of communications, usually computer terminals,

with such located in major centers like Newyork, London, Tokyo, etc, their

operations ae 24hrs and the daily turnover is in billons of dollars, thus these

markets are the critical element of the worlds financial mkt participants, are

usually dealers who buy and sell currencies, commercial banks and the

dealers- speculators. The official monitory authorities are also important

participants in that they intervene to smoothen the fluctuation. The

transactions done in spot and forward basis.

Authorized banks participating in the market normally have a separate

dealings room, where telephone lines are arranged on indirect switch broads,

enabling all dealers to listen in, thus keeping themselves informed on

exchange rate movements. The dealers have direct lines to brokers and to

other banks and important customers. In addition, dealers have telax

machines, sometimes with direct lines to their exchange braches in the

provinces and to banks in foreign centers. A deal concluded by telephone is

confirmed in writing.


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Mkt operation: the foundation of the mkt is the existence of international

trade, the growth of which depends on an efficient mkt where currencies

may be bought and sold. The mkt provides also the basic mechanism fro the

operation of the international monetary system, with intervention being

made from time to time by central banks to buy and sell currencies in order

to stabalize errectic movements in exchange rates which can fluctuate from

minute to minute, any appreciation and depreciation of currency, whether

brought about by floating or by a change of parity, is reflected in the market

and is instantly known through out the world, affecting market rates

accordingly.

Spot and forward rates: dealing rates are quoted spot, for foreign currency

bought and sold for immediate delivery 9in fact, it is normally delivered

after 2 days to allow fro time differences and for payment instructions and

confirmations to reach the most distant parts of the world0 or forward fro

currency to be deliverd on a date in the future at an agreed rate of exchange.

The forward dates most commonly quoted are 1,2, 3,and 6 months and one

year. Forward exchange cover is made available to traders as a from of

insurance that protects them against exchange risks arising fro ma move in

foreign exchange rates b/w the time when currency is to be received or paid.

An exchange rate coated for a forward date thus usually involves a premium

or discount as compared with the spot rate, depending on interest differential

rates b/w various international centers and general expectations about

relative movements b/w the currencies.

Currency dealings:


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Eurocurrencies, mostly dollars but also some of the leading European

currencies, received on deposit by authorized banks can be lent either in

the same currency or converted by the banks in to another currency,

including sterling. Members of the FECDBA usually act as intermediaries

b/w authorized banks in currency deposit business, although banks are free

to deal direct with other banks in the UK, if they so desire as well as with

banks aboard.

UK residents other than banks are normally given the exchange control

permission for foreign currency borrowing is for a period of at least 2

years. The financing of overseas as distinct from investments by resident

thru foreign currency borrowing is not affected by this restriction and is

normally allowed by the bank of England.

The term ;foreign exchange covers in its broadest sense, all payments an

receipts denominated in foreign currency. There are , however, other

separate markets, for example, in investments currency and in foreign banks

notes. Because of the specialized nature of these markets, transactions are

normally handled within the banks by specific departments or officials.

An Interest Rate swap is a legal agreement two or more parties to exchange

only their interest obligations in the same currency. This, obviously , does

not entail the exchange of the principal sums. By swapping his interest

obligations for another, a borrower can raise funs at a fixed rates, when

interest rates are rising and then switch to a floating rate in case interest rates

fall. And vice versa.


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Any borrower of foreign currency exposes himself to two types of risks:

exchange risks and interest rates risk. Raising a long term foreign currency

loan at a fixed rate of interest in a rising interest rate environment is all right.

But if interest rates stop rising and, on the contrary, fall sharply in a short

period of time, the decision to borrow at a fixed rate may prove to be wrong.

An expert group on the foreign exchange market in India was setup by the

RBI in November 1994, headed by shri O P Sodhani executive director ,

RBI, to recommend measures for developing an active, efficient and orderly

foreign exchange market in India. The group examined the terms of

reference in 4 different sub groups , issue- wise. The final report was

submitted towards the close of June 1995, an executive summary of which

has been released recently.

The report has identified constraints and short comings of the forex market

in India which was in its early stage of development and has now

considerably mature. It consist of a hand full of players, with a few public

sector banks dominating in merchant business and foreign banks leading in

inter- bank business. Owing to lack of integration between money and forex

markets and restrictions on borrowing and lending n international markets,

the forward rates do not reflect interest rate differentials. Prohibitions of

initiating transaction in international markets has restricted the cross

currency market. In hedging, free access is available only for forward

contracts and cross- currency options . ceilings on open positions have

inhibited the process of developing mkt in forex dealings. Against this back

drop: reccomdations of the panel have been grouped as flows:


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A] areas of relaxation :

1Guidelines on booking forward contracts should be amended, permitting

co-operates to take a hedge on dealaring the existence of an a exposure.

2. Banks should be permitted to decide their open exchange position limits

subject to earmarking of capital to the extent of 5% of the limits based on

international standards. They should similarly be permitted to have their

own ceiling on exposure gap based on capital and risk taking capacity.

3. banks should be given freedom to initiate cross- currency positions over

seas and to borrow or lend short term funds[up to 6 months] with a ceiling.

4. financial institutions should be permitted to freely trade in foreign

exchange to enlarge the market and encourage competition.

5. instead of a continuous presence in buying side, RBIs intervention

ensures orderliness in the market. RBI may consider influencing forward

rates by initiating swaps.

6. authorized dealers [banks] should be permitted to fix interest rates and

maturity periods for FCNR[ B] deposits, subject to a cap,

7. exporter should be allowed to retain the entire export earnings in India

after repayment of credit against export bills.

B] Development of derivative products: for this, the report has

recommended both short term and long term measures.

Short term measures include:

1. exemption of inter bank borrowings from statutory pre-emptions

which will facilitate an inter bank term money market and a well

developed rupee-dollar forward market.


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2. Corporates should be permitted to cancel and re- book option

contracts. Banks may be allowed to offer low cost stratergies like

range forwards.

3. banks should be allowed to offer any derivative, on a fully covered

basis, like swaps, caps, dollers, etc. they should be free to use such

products for their assets-liability management.

4. derivatives should be exempted from withholding tax.

5. while margin trading should not be allowed to export earners foreign

currency deposits may be used by corporates for access to hedging

products over seas. Among the long term measures are :

i. RBI should invite proposals from banks for offering rupee based

derivatives.

ii. Comprehensive risk management guidelines maybe formulated for

banks by RBI so that all products can be offered but not strictly on

a fully covered basis.

iii. Exchange control regulations should refocus on risks rather hen

products.

C] Risk management , Accounting and Disclosure standards:

1. risk management polices and internal control systems of internationally

accepted standards should be put in place by all market participants and

followed by banks, corporates and their auditors,

2. the foreign exchange dealers association of India[FEDAI] should

ensure uniform documentation and market practices.

3. The institute of chartered accountants of India should develop

accounting and disclosure standards for all the market participants.


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The companies act and banking regulation act should be amended

suitably to provide for disclosure of derivative exposures.

4. a uniform provisioning methodology, adopted by the group, should be

stipulated.

D] Others:

1. RBI should set up a foreign exchange market committee to advise it on

policy issues.

2. Offshore banking units should be set up in Mumbai. There should also

be a forex clearing house for settlement of inter bank forex transactions.

3. the role of FEDAI should be reviewed and enlarged.

The recommendation constitute an ideal combinations of autonomy with

safe guard for all participants necessary for the widening and deepening of a

nascent forex market.

The bulk of the govt of Indias foreign debt service payment, except its

repayment obligations to the inter national monetary fund will increasingly

be routed through commercial banks and not through the RBI. The

repayment obligation to the IMF will continue to be met through RBI.

Conclusion:

In the yrs to come the foreign exchange market is likely to play a pivotal

role in strengthening financial system and accelerate the process of

economy development.


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Forex Terminology:

Authorized dealers: banks which are engaged in the business of purchase &

sale of currencies. They require the RBI s permission under sec6 of FERA.

Exchange control: 1st introduced in India in the wake of 2nd world war in

1939, exchange control aims at conserving foreign exchange resources of the

country & optimize utilization in accordance with economic priorities.

Exchange rate: the rate at which 1 currency is converted into another

exchange rate can be quoted in 2 ways by direct method in which the local

currency varies [$1 =rs.45.6]; indirect method in which the foreign currency

varies[$2.50=rs 45].

Forward and spot rates: the forward rate is the 1 at which currency can be

bought or sold today for delivery at some future date. Spot transactions are

settled in 2 working days.

Intervention currency : the currency used in transactions are undertaken by

central bank to structure the exchange rate of its currency or the level of its

foreign exchange reserves.

2 way price: any quoting bank always a 2 way price, a price at which it buys

and a price at which it sells the currency. The spread between the buying &

selling rates should be sufficient to at least cover its costs.


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Vostro account: if an American bank has an a/c with an Indian bank in

Bombay, it is the American banks vostro a/c for the Indian bank.

Nostro account: if an Indian bank has an a/c with an American bank in New

York, it is the Indian banks nostro a/c.

Debt concept:

A variety of concept are used to measure and assess the economic burden of

debt. Debt stock, which is often reported as debt outstanding and disbursed ,

measures the total liabilities of the debtor. The payment obligation arising

from this is debt service and companies interest and principal payments. The

debts stock does not necessarily predict the debt service.

Two concepts describe the net effect of borrowings and repayments on the

flow of financial resources .

Public debt:

Public debt is raised by govt to meet the gap b/w the budgeted receipts and

payments. It has a far reaching consequences upon production andnn

distribution of a country. Public debt thus govt or state debt. The state

generally borrows to:

To meet budget deficits;

To cover other expenses ;and

To finance development activities.


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Industrial Finance for Merge

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