We spend our maximum part of our earning money because money is the lifeblood of our economy. Every country has its own currency which facilitates financial transactions within the national territory. When transactions go beyond the border, the concept of forex comes to our aid.
Forex stands for foreign exchange. Foreign exchange transaction means exchanges of foreign currencies with a domestic currency. In India, INR is domestic currency and USD is foreign currency. Therefore, purchase or sale of USD in respect of INR is considered foreign exchange transaction. Let’s understand this better with the help of an example.
The story of two medieval villages
Inram and Usduk are two villages located at the valley of mount Ejolum. None of the two villages adopted currency system yet, and still practicing their financial transactions through the barter system. One day, a wise man with white hair met with the chief of Inrum village and advised him to adopt the paper currency system and dump barter system. After a few meeting, the wise man finally managed to persuade the chief that if he moves out of the barter system and adopt the paper currency system, then financial transactions will be easier to execute.
Contemplating the advantages of the currency system, the chief decided to embrace the paper currency system and declared INR as it’s currency. He coined the currency name himself from the first three letters of village’s name Inrum. Villagers hailed their chief’s decision and flaunted their new currency in front of Usdukian counterparts. Observing the ease of executing transactions in the paper currency system in the Inrum village, Usduk also decided to adopt the paper currency system as well. They named their currency USD, chalked out using the first three letters of their village name Usduk.
Transactions within the territory of each villages were working fine, but the problem arose when merchants were trying to sell and buy goods from another village. The conflict started when buyers from Inram village wanted to pay using his home currency INR, whereas the sellers of Usduk village wanted to receive his payment on their home currency USD.
Chiefs of both the villages understood the problem and decided to summon the wise man who recommended them to adopt the paper currency system. They were confident that the wise man must have the solution to this problem. The wise man came and suggested to develop village-wise counters run by authorized agents, so that one can buy and sell USD in the village Inrum, and buy and sale INR in the village Usduk.
Despite the value of USD and INR is dependent on their respective village economy and the exchange rate occasionally fluctuates due to multiple factors, the system has suited well and inter-village transactions have started flowing very comfortably after that.
Foreign exchange management act,1999
Contrary to the above story where currency system is rudimentary in nature, our currency system in twenty first century is highly matured and well governed. Central Banks of various countries regulate, monitor and facilitate foreign currency transaction through the various way. In India, foreign exchange transactions are governed by Foreign exchange management act(FEMA), 1999.
FEMA,1999 has classified foreign transactions in two categories namely capital account transaction and current account transaction. Capital account transactions are those transactions which affect the assets or liabilities position of an entity. On the other hand, current account transactions are those transactions which are not capital account transaction.
FEMA,1999 prohibited certain transactions and allows other transactions with a limit on the amount. FEMA also stringently laid down provisions to facilitate repatriation of foreign currency. However, any person can keep any amount of foreign currency in the form of coins. Otherwise, a person can keep foreign currency with himself up to the value specified in the FEMA, 1999.
In India, foreign currency can be purchased only from the authorized agent of Reserve Bank Of India. FEMA,1999 mandated heavy penalty and stringent imprisonment in case of violation of the provisions made under the FEMA,1999.
FOREX trading in India
In India, trading in foreign exchange is prohibited except following four pairs of currency
A person can legally trade in foreign currency with Indian brokers who trade on exchanges like NSE, BSE, MCX because they provide access to currency derivatives. RBI prohibits trading in currency pairs other than aforementioned currencies to restrict outflows from foreign currency reserves. However, forex trading is perfectly legal in countries like USA, UK, and Canada. Citizens of those countries can start forex trading through the platform like FXCM.
Forex trading is very lucrative in terms of profit but it comes with a higher degree of risk. Before starting to trade in foreign currency, one must understand that the forex market is highly volatile which makes new trader susceptible to heavy loss sometimes leading to complete erosion of capital. Therefore, a person must go through proper technical training to gain hands-on experience. You may educate yourself to forex trading by taking Udemy course. Please share your views and experience on forex trading in the comment section below.