Saturday, November 7, 2009

A Layman's peek into foreign exchange matters

When I boarded a KLM plane to Amsterdam in 1975, I had less than 20 British Pounds with me as foreign exchange. One Pound used to be equal to Rs.14 at that time. Why only 20 Pounds? Why not more? That was the limit imposed by the Indian Government for travellers from India. Those were the days when the country had very little foreign exchange and every dollar or pound the Govt. had in foreign exchange reserve was precious , mainly used for unavoidable imports. How would I have survived with that little foreign exchange in Europe and for how many days ! But then I was to get an advance payment as soon as I reached Munich , from the company I was going to work for. So, I had to manage on my own and with 20 Pounds only for two days. But, when I reached Amsterdam on a misty Sunday morning and was looking forward to board a connecting flight to Munich, I was told that due to weather conditions, the flight to Munich was cancelled. I should either wait overnight in Amsterdam and take the next morning flight to Munich or go to the Amsterdam Railway station and take a train to Munich. What a shock ! But then I managed ; got a transit visa to get out of the Airport, travelled to the Railway Station by the KLM bus, bought a second class ticket for 150 Dutch Guilder to Munich and slept my way to Munich. This could not have been possible with the 20 Pounds ; but then the intelligent travel agent back in India knew how to circumvent the rules and made sure that when I made that bus trip to Amsterdam Railway Station, my pocket had more foreign currency notes than when I landed at Amsterdam Airport. No need to go into the details ! All is well that ends well.

Nowadays, the Indian Govt. kitty is bulging with foreign exchange. A year ago, the Govt. brought some restrictions on the incoming foreign money so that Indian Rupee did not appreciate too much, inconveniencing Exporters. What a drastic change ! Any tourist can take up to 10000 USD out of the country for his travel expenses. For business purposes, it is 25000 USD.

Of course, restrictions, as the above amounts suggest, still exist. There is only current account convertibility, not capital account convertibility. One can travel abroad more comfortably, get educated in foreign universities, get treatment in hospitals abroad etc. But one can not invest abroad. Moreover, while in India, one can not keep financial assets in foreign currency ( may be, one could keep a very restricted amount). Unless full convertibility happens, this situation will not change. All developed countries have full currency convertibility. That is why Dollar or Euro is accepted everywhere in the world. Rupee is not accepted anywhere in the world except in Nepal and Bhutan. But experts say that India can not afford full convertibility at this stage since such a step is fraught with major risks. The East Asian crisis is still fresh in mind.

In 1975, one U.S.Dollar fetched Rs.8. Today, it is Rs.46.- Why did this happen? One major reason is that the annual inflation in India has, on a long-time average, been around 8% while in the U.S. it has been 2 to 2.5 %. So, over the years the divergence between a dollar's purchasing power in the U.S. and the Rupee's purchasing power in India has grown enormously. While the foreign exchange Pundits would not like to simply the matter so much and would suggest many other reasons for this change in exchange rate, this is the most believable explanation in my eyes.

Since this subject of foreign exchange has always fascinated me, I could share some more observations here.

1.Of all the currencies that have appreciated, nothing has appreciated more than Swiss Frank. In 1975/76, one dollar could buy two Swiss Franks. Today, one dollar just about manages to get exchanged for one Swiss Frank.

2.Deutsche Mark does not exist any more. But projecting its possible exchange rate on the basis of Euro's performance , a DM if it lived today would have been equivalent to 75 U.S.Cents. In 1976, one DM was 50 U.S.Cents.

3.The Canadian Dollar has appreciated considerably. A Canadian Dollar today fetches 92 U.S.Cents, whereas 30 years ago, it trailed far behind.

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