Exchange Rate and Currency Research Paper

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International Economics Research

In the contemporary, there is continued deliberation regarding the future of the International Monetary System. Subsequent to the international economic and financial crisis, compounded with the rise of China as the second biggest economy and circulation of the Euro, there has been deliberation of other currencies joining the U.S. Dollar as the reserve currency of the IMF. This report is an attempt to examine the prevailing position of the Indian Rupee in terms of becoming an international currency and its involvement in the International Monetary System. India has materialized as the fastest growing key economy in the world. The enhancement of the nation's economic rudiments has fast-tracked in the year 2015 with the collective impact of strong government reforms. Taking into account the characteristics of an international currency within the international monetary system, such as the U.S. Dollar and the Euro, the current status of the Indian Rupee is yet to solidify as an international medium of exchange. The Indian Rupee fails to satisfy the features of a global currency. The nation needs to have significant improvement in its GDP, its foreign exchange turnover rank and also the share of trade.

Introduction

In recent years, there has been considerable debate over the future of the International Monetary System. The global economic and financial crisis cast doubts regarding the prevailing global exchange rate system. The string instabilities in exchange rates, regardless of whether it is between the U.S. Dollar and the euro or currencies in Eastern Europe, repeatedly give rise to uncertainties in the financial market. Similarly, fixed exchange rates, for instance, between China and the United States, are an underpinning for accrual of major imbalances (Belke et al., 2011). Since the Second World War, the United States Dollar has been the reserve currency of the International Monetary Fund. However, the forthcoming periods may encompass other currencies with the Chinese Renminbi, Indian Rupee and Brazilian Real becoming a part of a multi-polar currency system with the Dollar and Euro (Kadyan, 2014).

Indian economy is amongst emerging economies in the globe, experiencing a high growth rate. The nation's market share in global trade has also increased in recent years. Taking into account the size of the nation and future prospects, India cannot be overlooked. India is also steadily growing to be a sought-after destination for Foreign Direct Investment (FDI) and Foreign Institutional Investors (FII). What is more, there has been a progressively increasing demand for the Indian Rupee in the global financial markets, to the extent that a number of transnational institutions have begun to issue financial bonds in Indian Rupee (Kadyan, 2014). The inference of this is that there are good prospects of the Indian Rupee becoming an international currency. The purpose of this report is to examine the different factors that influence this aspect in relation to the international monetary system.

The following are the proposed research questions to be evaluated and reviewed in this report:

1. Taking into account the characteristics of an international currency within the international monetary system, such as the U.S. Dollar and the Euro, what is the current status of the Indian Rupee at the international level?

2. What are the aspects that aid in making a currency a global or international currency, and where does the Indian Rupee stand with regard to these aspects?

3. What role is the Indian Rupee going to play in the future as an off-shore currency, taking into consideration the nation's endeavors to increase local currency trade?

Literature Review

The International Monetary System has evolved in different phases, which include the gold standard era (1819-1914), the interwar period (1914-1939), the post-World War II

Bretton Woods System (1946-1973) and the present post-Bretton Woods System (1973 to present) (Lin et al., 2012). During the gold standard epoch, majority of nations were on some kind of the gold standard. However, China and India were significant exclusions as they maintained a silver standard. In the interwar phase, the UK and the U.S. had been allowed to possess gold reserves; however, other countries might possess both gold as well as pounds or dollars as their reserves with the purpose of evading the issue of gold shortage. The Bretton Woods System brought about fixed exchange rates against the U.S. dollar, which had a fixed price in terms of gold at U.S.$35 per ounce (Lewis, 2015). Subsequent to the demise of the Bretton Woods System, the fixed price in terms of gold at U.S.$35 per ounce was scrapped off. To the present day, the dollar has maintained its position as the dominant currency in the international monetary system.

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In accordance to basic monetary economics, within an economy, money serves three elementary functions, which include serving as a unit of account, as a medium of exchange, and as a store of value. Likewise, an international currency serves equivalent functions in numerous economies. An international currency as a unit of account, is employed to charge commodities of trade, as a denomination in financial transactions, and to delineate exchange rate uniformities (Tavlas, 1998). Secondly, as a medium of exchange, an international currency is utilized in the direct exchange of currencies and as a vehicle currency in executing indirect exchanges between two other currencies in foreign trade and global capital transactions. In addition, it is employed for financing balance of payments and as a vehicle for exchange market involvement. Lastly, as a store of value, an international currency is employed in the selection of financial assets, for instance financial bonds and holding the currency as a reserve (Tavlas, 1998).

Kadyan (2014) outlines the main characteristics of an international currency to include international financial market domination, invoicing currency, pegging currency, reserve currency, and hand-to-hand currency. International currency is employed for charging or pricing of international trade. In particular, it is utilized even when no partner in the trading transaction is the origin nation of that currency (Kadyan, 2014). Krugman (1984) outlines this aspect using the U.S. Dollar. In goods trade between any two nations, there is a predilection for demanding payment in exporter's currency, but also a predilection for demanding payment in the currency of the bigger nation. This, in itself, offers the United States, as the biggest economy in the globe, a lopsided share of the invoicing. Moreover, a great deal of trade, regardless of whether it involves the United States or not, is invoiced in dollars. In monetary transactions, the dollar is the prevailing currency for global borrowing and lending, though this supremacy is not comprehensive (Krugman, 1984).

International currency is employed for denominating securities in the global financial market. Majority of global securities are issued in the lead international currency (Blinder, 1996). The role played by the international currency in the global financial market is measured by foreign exchange revenue of a currency, cross border claims in currency, global debt or bond securities denominated in that currency (Kadyan, 2014). According to Goldberg and Tille (2008), a currency is deemed to be a hand-to-hand currency at the global level when it is employed by non-residents for their transnational trade disbursement and for their resident practices as well. In nations with high inflation, even the resident trading is undertaken in the foreign currency. This may be implemented formally, also referred to as dollarization, or implemented behind closed doors. In numerous nations, the U.S. Dollar is employed as the second major currency or in other cases, has entirely replaced the local currency (Goldberg, 2010). Indian rupee is employed as a hand-to-hand currency in a number of nations at a low measure. According to Kadyan (2014), Indian Rupee is accepted in Bhutan and other towns in Nepal. What is more, the currency is also espoused in other nations including Sri Lanka, Malaysia, Indonesia, Singapore, and the United Kingdom. Therefore, Indian rupee is employed as hand-to-hand currency at a number of expanses, but its role is very trifling, as international currency used for medium of exchange (Kadyan, 2014).

Pegging takes into account the fixing of exchange rate between two currencies. As outlined, this is when a nation pegs its currency with another currency, and thereafter endeavors to sustain a fixed exchange rate between two currencies (Page, 1981). This is undertaken when the government or central bank intervenes in the foreign exchange market. By far and large, pegging is undertaken either to a key trade partner's currency to sustain unpredictability of exchange rate or with a strong currency for monetary and fiscal policies to stay in some particular borders (Obstfeld & Rogoff, 1995; Kadyan, 2014). Three decades ago, majority of the world trade was pegged to the dollar. In the contemporary, only a restricted number of smaller nations continue to be. Nonetheless, this does not signify the rise of a contending currency, but the relinquishment of fixed rates completely (Krugman, 1984). According to Kadyan (2014), the Nepali rupee and Bhutan ngultrum are pegged to the Indian Rupee. At the outset of the 60's period subsequent to the formation of Nepal Rastra Bank, Nepali rupee was pegged to Indian rupee at the….....

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