Components of demand for foreign exchange

Imports of Goods and services

When I buy goods or services from another country, it is called Import.

Example of book import by an individual

Suppose you want to buy a book written by a foreign author from the USA. You order it online. But the seller in the USA won't accept Indian Rupees. They will ask for US Dollars instead.

So, you'll have to go to the bank, buy US Dollars, and then pay the seller.

Example of Raw Material Imports by a producer

Imagine an Indian company wants to buy uranium from Australia. Uranium is used in nuclear power plants, and Australia has plenty of it.

To buy uranium, the Indian company needs Australian Dollars. The Australian seller won't accept Indian Rupees. They'll say, "No Indian Rupees, please! Give me Australian Dollars."

So, what will the Indian company do? It will:

1. Go to a bank in India.
2. Exchange Indian Rupees from its account for Australian Dollars.
3. Use those Australian Dollars to pay the Australian seller.
4. Get the uranium from the seller.

This is foreign exchange in action! The company exchanges Indian Rupees for Australian Dollars

Or we can take another example. Tata Motors imports auto parts from Japan, to manufacture cars, worth ¥500,000. They will need to buy Japanese Yen for making payment.

Example of service import by an individual - Education Service

Suppose you want to take a foreign exam. Usually, you take coaching in India. But for a foreign exam, you'll learn from a foreign teacher, maybe from the USA or China.

They'll teach you online, and you'll study with them daily. Here, you're importing a service, even though it's invisible. Since it's from a foreigner, it's called importing foreign service.

Example of service import by an individual - Medical Service

If you're sick, and you have an online consultation with a foreign doctor, that's also importing a service. Suppose Virat, a young Indian cricketer, suffers a shoulder injury during a match. He wants the best treatment, so he consults Dr. Smith, a renowned sports injury specialist from the UK. Through video calls, Dr. Smith analyzes Virat's injury and provides him specialized treatment plan. Virat pays Dr. Smith in British Pounds (GBP) for the online consultations.

Investments in Rest of the World

"Suppose I'm a producer and I want to invest in another country. This means I want to set up an office or factory there. I'll buy materials and materials locally from there only.

So to set up operations there , I'll need the local currency of that country. This is called foreign investment.

When investing in any country outside India, you'll need that country's money (foreign currency).Examples: a) Setting up offices abroad b) Buying machines for a factory c) Purchasing land or buildings for business

Let's say Indigo Airlines or Tata Airlines want to open offices in another country. They'll need:

• Local currency to buy office buildings
• Pay local sellers in their currency (foreign currency)

This is considered foreign investment, and we need the local currency to make it happen."

We can take another example

Suppose someone has to open a new restaurant in the US. He will need:

• Dollars to rent a place
• Dollars to buy equipment
• Dollars to hire staff

That's foreign investment! And you need foreign currency to make it happen."

Grants and Donations paid to rest of the world

Sometimes, we need to donate money to other countries. Suppose there's an earthquake or volcano eruption, and we want to help. Our government wants to support that country, so we send donations. But if we send Indian Rupees, they'll say:

"Hey, we can't use Indian Rupees! What will we do with it?"

To help, we need to send money in their currency. For example, if we're supporting Dubai's government, we need to send Dubai's currency (Dirham).

We need foreign currency for:

• Grants
• Donations
• Humanitarian aid

This way, our help reaches those who need it, in a currency they can use."

Just like how Indian Rupees work here, other countries need their own money to:

• Rebuild after disasters
• Support their people
• Fund projects

Payment of Factor Income

Suppose I need to pay rent to someone in another country. Let's say Tata sets up an office abroad, but instead of buying, they rent it.

The landlord is from that country and will ask for rent in their local currency.

This is called "payment of income" abroad. It can be payment for any type of factor income

• Rent
• Interest
• Profits
• Dividends

Direct Purchases Abroad

Imagine you travel abroad for vacation, medical treatment, or studies. Direct purchases means that you buy things directly there. You are not importing things sitting in India.

Suppose you go to US for medical treatment. You will surely buy medicines from there. You won't come back to India to buy these, right? You will buy medicines, pay hospital bill, etc.

If you go to study abroad, you'll buy books there, not fly back to India to buy them, right?

In short when Indians travel abroad for various reasons, they need foreign currency to purchase different goods and services from there. Examples - Books, Hotel stay, taxi fare, food and other daily expenses. In fact, for everything you buy or use abroad, you will need foreign currency."

This is called direct purchase abroad, and it's a common reason for buying foreign exchange.

As a student, as of now you are not much concerned about making donations abroad or making investments abroad. But direct purchase abroad affects your life. Ask your relatives, friends, or neighbors who've traveled abroad or have family living abroad. They'll tell you that they needed foreign currency. You might even find foreign currency at their homes!"

Repayment of International Loan

Suppose you borrow money from:

• A foreign bank
• A foreign government
• A foreign country

while living in India. To repay the loan, you'll need to send money in their currency. This means you'll need foreign currency for loan repayment."

Example - Infosys, an Indian IT company, borrows USD $100 million from a US bank. When they repay the loan, they will need to buy USD, using foreign exchange services.

Speculative Trading

"Suppose I expect the US Dollar (USD) to increase in value after a few months. To profit from this, I'll:

1. Buy USD today
2. Hold it for a few months
3. Sell USD when its value increases

Buy USD now → Hold → Sell later at higher price = Profit!

This is called Speculative Trading. It's like betting on currency price movements to earn profits.

Want to learn more about speculation? Click here.

When someone buys foreign exchange to make profits, it creates demand for foreign currency. This is another reason why people need foreign exchange."

Remittances abroad

Sometimes people in India sends money to someone abroad. For this they first need to buy that country's currency.

Example - Karina, an Indian student, enrolls in a US university for her master's degree. She needs USD $20,000 per semester. Her parents transfer funds from India to the US using foreign exchange services.

"And that's not all! Initially, we thought foreign exchange was only for travel. But look at all the reasons we need it for.