ICom Notes Class 12 Banking Rate of Exchange, Fluctuation and Objectives of Exchange Control

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RATE OF EXCHANGE

The rate at which the currency or monetary unit of one country can be exchanged with the monetary unit of other country is called the rate of exchange. In other words, the rate at which a unit of one country exchanges for the currency of another is the rate of exchange between them. It may be used to denote the system whereby the trading nations pay off their debts.

Determination of Rate of Exchange

The rate of exchange is determined under the following under the following money systems as:

Under Gold Standard

If two currencies are on gold standard and if their currencies are expressed in terms of gold i.e. a certain weight of gold then the rate of exchange is determined by reference to the gold contents of the two currencies. Suppose Pakistan and United States are on gold standard the rupee being equal to 10 grams of gold and dollar consisting of 50 grams of gold. The rate of exchange between the two countries will be

1 Rupee = 10/50 = 1/5 $ or 0.20 cents

1 Dollar = 50/10 = 5 Rupees.

Thus the rate of exchange is determined in a direct manner by comparison between the gold contents of the two countries. This rate of exchange is also known as Mint Par of Exchange. The actual rate in the foreign exchange market will be slightly different from the mint par to allow for certain expenses. However the actual rate of exchange between currencies will not depart much from the mint par and will move between the two points of export and import of gold. These points are called Gold Points.

Under Paper Currency Method

This phenomenon of exchange rates determination is also called Purchasing Power Parity Theory. No country in the world is rich enough to have a free gold standard. All countries nowadays have paper currencies. According to this theory the rate of exchange between two countries depend upon the relative purchasing powers of their respective currencies. Such will be the rate which will equate the two purchasing powers.

For example if a certain assortment of goods can be purchased for ₤ 1 in Britain and a Similar assortment of goods with Rs. 16 in Pakistan then the purchasing power of ₤ 1 is equal to the purchasing power of Rs. 16. Thus the rate of exchange according to purchasing power parity theory will be

₤ 1 = Rs.16

Fluctuation in Rate of Exchange

Q.24. What are the causes of fluctuation in the rate of exchange of a country? The rate of exchange fluctuates in the market due to interplay of demand and supply of currency of a particular country. This is the result of some of the following transactions.

BALANCE OF TRADE

The main reason for fluctuations in the rate of exchange of the currency is the value of imports and exports of a country. If the value of imports exceeds the value of exports the rate of exchange will lend downwards and vice versa.

FOREIGN INVESTMENT

Foreign capital investment in a country necessities the payment of dividends or interest to the investing countries. If the capital absorbing country is not in a position to pay such claims in foreign currency, the rate of exchange of that country will definitely fall down.

SERVICE CHARGES

Freight and Insurance expenses also fluctuates the rate of exchange of a country. If the importing country does not have her own shipping companies the transportation charges are to be paid to foreign ships. So the insurance premium in case is to be paid to foreign companies. This creates a demand of foreign currency and if the supply is limited the rate of exchange will fall.

OBJECTIVES OF EXCHANGE CONTROL

The following are some of the objectives of exchange control.

To restore Equilibrium

The chief objective of exchange control is to restore equilibrium in its balance of payments. If a country finds that its balance of trade has been persistently unfavourable then it must do something set it right. The balance of payment must ultimately be made to balance.

To Protest Home Industries

Another objective of exchange control is to protect the home industry from unfettered competition from abroad if the people at home are more interested in purchasing foreign goods it will ultimately discourage the local producers to produce more. It will directly affect the National Income and the domestic Gross Product of the country.

To Conserve Foreign Reserves

To conserve foreign reserve is another major objective of exchange control. Every Country needs foreign exchange in order to maintain its stability monetarily in the present age. Also the countries need foreign exchange to make payments for their imports and to pay back their debts obligation. For this a country must have foreign currencies on their hand. If there is a deficiency of the foreign exchange it is going to affect its liquidity position internationally and its credit rating.