Understanding Foreign Exchange Rates

Understanding Foreign Exchange Rates :

Exchange Rates

Export contracts are concluded either in native currency or in foreign currency. Where the contracts are in Indian rupee, the related documents are also prepared in native currency and no conversion is involved. However, where the bill is drawn in foreign currency, like US $, £, DM etc., you will get native currency only after the conversion of foreign currency at the appropriate exchange rate. Thus the exchange rates become very important to determine the native currency payable. A favourable exchange rate will fetch you more rupees and vice-versa. It, therefore, becomes essential for you to gain some basic knowledge about exchange rate, the working out of its quotation by the banks, the factors determining the exchange rates in the market and the precautions you should take so as to avoid possible losses in future, due to adverse movement of exchange rates.

In the following paragraphs we shall endeavour to explain these issues.

The rates applied by the banks for converting foreign currency into native currency and vice versa are known as exchange rates. In other words, exchange rate is the rate at which one currency can be exchanged for another.

There are two systems of quoting exchange rates.

Direct Quotation

Where the price of foreign currency is quoted in terms of home or local currency…. In this system variable unit of home currency equivalent to a fixed unit of foreign currency is quoted.

For example : US $ I = Rs. 47.00

Indirect Quotation

Where exchange rates are quoted in terms of variable units of foreign currency as equivalent to a fixed number of units or home currency….

For example : US $ 2.1275 = Rs. 100

Banks were required to quote all the rates on indirect basis as foreign currency except in case of sale / purchase of foreign currency notes and traveler cheques where exchange rates on direct quotation basis were quoted. Now banks are quoting rates on direct basis only.

There is a distinction between inter-bank exchange rates and merchant rates.

Merchant rates are the exchange rates applied by the bankers for transactions with their customers for various purposes, such as import, export, travel, remittances etc. These rates are calculated by the banks as per the guidelines issued by the Foreign Exchange Dealers Association.

On the other hand inter-bank rates are the rates for transactions amongst the authorised dealers in foreign exchange. These rates depend on the market conditions. It is not out of place to mention here that exchange rates are volatile and, therefore, you should make sincere efforts to choose appropriate time for tendering your export documents to the bank for purchase / negotiation. Therefore, plan your affairs in such a way that the documents are delivered to the bank when the exchange rates are favourable enabling you to get more money after conversion of foreign currency amount of the bill into native currency.

A distinction is also made between spot rates and forward rates. Spot rates are applicable on the day of transaction, i.e. the same day, whereas forward rates are the rates fixed in advance for a transaction which will mature at a specified date or during a specified period in future. Quotations for spot rates only are generally available and the customers have to enter into specific contracts for forward rates.

Foreign exchange rates are always quoted as two way price i.e...a rate at which the bank is willing to buy foreign currency (buying rate) and a rate at which the bank sells foreign currency (selling rate). Banks do expect some profit in exchange operations and there is always some difference in buying and selling rates. However, the maximum spread available to banks is restricted in terms of ceilings imposed by Reserve Bank.

All exchange rates by authorised dealers are quoted in terms of their capacity as buyer or seller. Different sets of exchange rates are applied for various types of foreign exchange transactions as under….

TT Selling Rate

This rate is applied for all clean remittances outside your country i.e... for selling foreign currency to its customer by the bank such as for issuance of bank drafts, mail / telegraphic transfers etc.

Bill Selling Rate

This rate is applied for all foreign remittances outside your country as proceeds of import bills payable in your country. This rate is a little worse than IT selling rate.

TT Buying Rate

This rate is applied for purchase of foreign currency by banks where cover is already obtained by banks. Thus all foreign inward remittances which are made payable are converted by applying this rate. A mail transfer issued by a bank in Dubai for US $ 10,000 drawn on (say) Oriental Bank of Commerce, New Delhi, will be converted into rupees at IT buying rate as the bank in Dubai would have already paid the US $ in bank a / c of Oriental Bank of Commerce in New York.

Bills Rate

This rate is applied for purchase of sight export bills which will result in foreign remittance to after realisation. This rate is worse than IT buying rate and, in addition, interest will also be recovered by the bank for the period for which the bank is out of funds.

Forward Contracts

As regards elimination of exchange risk due to unfavourable movement in the exchange rate, the same can be avoided by the following methods.

I. By invoicing in native currency

2. By fixing the foreign exchange contract

First alternative is possible only when the buyer agrees to it. He may have his own reasons for not agreeing to invoicing in native currency. The second alternative is commonly resorted to. This alternative involves booking of forward exchange contract with your bank. This means that pending submission of documents to the bank for purchase / negotiation, you have made firm commitment with the bank under which you agree to sell to the bank foreign exchange at a future date / period and the bank agrees to purchase at the firm rate the foreign exchange to be tendered by you on that date / during the agreed period. Thus you are in a position to know in advance the exchange rate you are going to get on submission of your export documents. Thus, though you have to pay some charge for booking a forward contract, you are certain about the rupee amount of the bill on conversion of foreign currency at a future date.

For booking a forward contract, you should approach your bank with which you are enjoying a credit limit. The bank will book a forward contract only against a firm export order showing description and quantity of the goods to be supplied, aggregate price and approximate date of shipment. The bank can accept telex, cable order/fax in this regard, provided you give an undertaking to produce the original one. Where shipment has already been completed, forward contract will be booked on the basis of export bill Tendered by you. It can be booked against an irrevocable Letter of Credit provided L / C is complete in all respects and you give a declaration to the bank that you have not booked any forward contract against the underlying sale contract covering shipments under the L / C.

You must ensure delivery of the related documents within the agreed period of the contract. In case you fail to deliver the documents within the specified period, the forward contract needs to be cancelled and fresh contract booked for which your bank will levy cancellation charges as per the FEDAI Rules. In case the documents are delivered before the stipulated period, it will involve early delivery and bank will levy charges for the early delivery, as per FEDAI Rules. Where the documents are not delivered at all, contract has to be cancelled either at your request or by the bank itself under certain circumstances and this will entail cancellation charges as per the FEDAI Rules. It, therefore becomes extremely important that the period of delivery of the export documents is carefully chosen and strictly adhered to so as to avoid unnecessary charges on account of early delivery or cancellation of forward contracts. However, facility for substitution of contracts covering trade transactions is permitted, if the authorised dealer is satisfied after verification of suitable documentary evidence with the circumstances under which such substitution has become necessary.

A strategic policy should be adopted for forward contracts. Exporters can improve profitability by properly blending forward and open position anticipating the expected trend of currency behavior. For commodity exports where turnover is high and profitability is low, this strategy is especially useful.

How to Export? Index

Understanding Foreign Exchange Rates To HOME PAGE