It is close to the month-end and you realize you need to go for your monthly shopping. Let’s say you need to get some snacks, fruits, clothes, personal care products, stationery, and utensils but you don’t have the time to go around the town visiting different shops for different items. Where would you go? Supermarket! A supermarket would be like your one-stop solution for all the things you need.
Now, think of the Indian Financial Market as a supermarket, where all kinds of financial assets/instruments can be bought and sold. Would you like to know more? I got you! In today’s blog, we will be understanding what is a Financial Market. Who are the market participants? Why is it important? and What is the structure of the Financial market in India? So, let’s get started!

What is the Financial Market?

I guess the name suggests itself. The Financial Market is a marketplace, where buying and selling of various financial asset/instrument take place. The financial assets being traded in this market can be stocks, bonds, currencies, commodities, etc. It brings together the buyers and the sellers who are interested to trade in a particular instrument. So, the stock market, bond market, forex market, commodities market, and any other market trading in financial instruments together, fall under a single umbrella, which is the Financial market. These markets operate in a proper structure but, more on that later.

Participants include investors (institutions, individuals, government, etc.) wishing to invest in various investment avenues, entities /governments wishing to raise funds, financial intermediaries (exchanges, brokerages, banks, mutual funds, etc.) and regulatory bodies (RBI, SEBI, etc.).

What is the importance of the Financial Market?

• Enables smooth circulation of Funds :
  

The market participants continuously interact with each other. Thus, funds flow efficiently from investors to businesses/government and vice versa.

• Encourages people to invest :
  

Various financial instruments like stocks and bonds have given better returns than traditional options like FD’s or Savings. Improved transparency, proper regulation and rising financial literacy in India have ultimately encouraged people to trust and earn good returns by investing in markets.

• Reflection of economic growth :
  

  I think the 2008 crisis would be the best example to understand this point. The financial market and economic growth go hand in hand. The performance of financial markets is reflected in the strength of the economy.

It said, “Everything is fair in Love and War!”, is it?

The economic devastation caused by the Great Depression in the 1930s left many countries struggling with high unemployment rates, poverty, and political instability. Many countries, including the United States, implemented protectionist trade policies in response to the Great Depression. This led to a decline in international trade and increased competition for resources, creating tension between countries. Countries had also engaged in competitive devaluations of their currencies, which destabilized the global economy and along with a few other factors contributed to the outbreak of World War II.

Towards the end of World War II, a collective need was felt to take steps to prevent a repeat of the economic chaos that had occurred during the interwar period, which had contributed to the outbreak of the war, which brings us to the Bretton Woods Agreement.

What was the Bretton Woods Agreement?

The Bretton Woods Agreement was signed in July 1944, toward the end of World War II. The agreement was negotiated by representatives of 44 Allied nations at a conference held in Bretton Woods, New Hampshire, USA. The main purpose of the agreement was to establish a new international monetary system that would help to promote economic stability and prevent a repeat of the economic chaos that had occurred during the interwar period.

It aimed to establish a system of fixed exchange rates, with the US dollar as the world's reserve currency. Under the agreement, other currencies would be tied to the US dollar at a fixed exchange rate, and central banks would be able to convert their dollars into gold at a fixed rate of $35 per ounce.

The two main parties to the agreement were the US and the UK, which were the dominant economic and military powers at the time. The US played a leading role in the negotiations and had the most influence over the final outcome of the agreement.

But why do the United States and the US Dollar have an upper hand in this agreement?

The US was a dominant economic and military power at the time. They had emerged from World War II as the world's largest economy, with a powerful military and vast reserves of gold. The US also had a vested interest in promoting international trade and investment, as it was a major exporter of goods and services.

In contrast, Europe was in a weakened state after the war, with its economies and infrastructure badly damaged. Europe also faced a number of political and social challenges, such as the need to rebuild their societies and economies, and the rise of communist movements.

Given these circumstances, the US was able to use its economic and military power to shape the terms of the Bretton Woods Agreement in its favor. The US was able to establish the US dollar as the world's reserve currency, and other countries were required to tie their currencies to the dollar at a fixed exchange rate.

What did the Bretton Woods Agreement facilitate and what was its impact?

As mentioned earlier, the Bretton Woods Agreement facilitated international trade and investment by providing a stable framework for the exchange of currencies. It provided a mechanism for countries to settle their international accounts through the International Monetary Fund (IMF). The IMF was established to provide loans to member countries facing balance of payments difficulties and to oversee the exchange rate system to ensure that countries complied with the rules of the agreement.

The agreement had a significant impact on the global economy and international trade. The fixed exchange rate system helped to promote economic stability and facilitate international trade and investment. Countries were able to rely on stable exchange rates when making international transactions, which helped to promote economic growth and reduce uncertainty. Growth was also seen in the international financial markets, as investors were able to make international transactions with greater ease and confidence. The agreement helped to promote the development of new financial products, such as international bonds and currency futures, which facilitated international investment and trade.

The Bretton Woods Agreement also helped in the reconstruction of Europe after World War II. The US provided significant financial assistance to Europe through the Marshall Plan, which helped to rebuild the economies of Western Europe and promote economic integration in the region.

And last but not the least, this agreement helped the United States to establish the US dollar as the world's reserve currency, which gave the US significant influence over the global economy. The US was able to print dollars to finance its international obligations, such as military spending and foreign aid, without having to worry about the value of the dollar being eroded by inflation.

End of the Bretton Woods Agreement -

Despite the initial success of the Bretton Woods Agreement, the system came under strain in the 1960s as the US experienced rising inflation and balance of payments deficits. The US government had been spending heavily on the Vietnam War and domestic programs, while also maintaining a fixed exchange rate system that required the country to maintain a stable supply of dollars.

As a result, the US began to print more dollars to finance its obligations, which led to inflation and a loss of confidence in the US dollar. Other countries began to demand gold in exchange for their dollars, which put pressure on the US gold reserves. Therefore, in 1971, President Richard Nixon announced that the US would no longer exchange dollars for gold, effectively ending the Bretton Woods Agreement. This event marked the end of the fixed exchange rate system and the beginning of a new era of floating exchange rates, in which currencies fluctuated in value based on market forces.

How did the end of the Bretton Woods Agreement impact the world?

The end of the Bretton Woods Agreement had a significant impact on the global economy and international trade. The floating exchange rate system led to greater volatility in currency values and made it more difficult for countries to manage their economies and conduct international transactions. It had major implications for developing countries, which were often at the mercy of market forces and vulnerable to sudden shifts in exchange rates. The IMF continued to play a significant role in managing the global economy, but its effectiveness was limited by the lack of a fixed exchange rate system.

In the years following the end of the Bretton Woods Agreement, there were many attempts to create new international monetary systems that could better manage the global economy. One such attempt was the European Monetary System (EMS), which was established in 1979 and aimed to promote monetary stability in Europe through a system of fixed exchange rates. The EMS was ultimately unsuccessful, and the system was replaced by the European Economic and Monetary Union (EMU) in 1999 which established the euro as another major reserve currency in the global economy.

Another attempt to create a new international monetary system was the Plaza Accord, which was signed by the finance ministers of the US, Japan, West Germany, France, and the UK in 1985. The accord aimed to address the issue of the US dollar's overvaluation and led to a significant depreciation of the dollar against other major currencies. It was successful in reducing the US trade deficit and promoting economic growth in other countries, but it also contributed to the growth of Japan's export-led economy and the subsequent economic bubble in the country.

Legacy of the Bretton Woods Agreement:

The legacy of the Bretton Woods Agreement is the role of the US dollar as the dominant global reserve currency. While the dollar has faced challenges in recent years from the rise of other currencies like the euro and the Chinese yuan, it remains the world's most widely held reserve currency. The use of the dollar as a reserve currency has helped to cement the US's position as the dominant global economic power, but it has also led to concerns about the stability of the global economy and the potential for financial crises.

As the global economy continues to evolve and new challenges emerge, it is important to learn from the lessons of the past and to work towards creating a more stable, sustainable, and equitable international economic system. Whether through reforming existing institutions or creating new ones, there is a need for continued efforts to promote economic development and stability for all countries around the world. Until next time…

Yesterday, Donald Trump who served as the president of the United States from 2017 to 2021, said that “Dollar is crashing and will soon no longer be the world standard”. This statement sparked speculation and concern about the future of USD & global trade.

Firstly, it's important to understand what it means for a currency to be the world standard. The US dollar has held this position since the end of World War II, largely due to the strength and stability of the US economy. As the world standard, many countries use the dollar as a reserve currency, meaning they hold large amounts of dollars in their foreign exchange reserves. Additionally, most international trade and financial transactions are conducted in dollars. This gives the US a significant amount of influence over global economic affairs.

However, Trump's warning that the dollar could lose its status as the world standard is not a new concern. Many countries, have been looking for ways to reduce their dependence on the dollar and increase their own currencies' importance on the global stage. This is also called as “de-dollarisation” move. It is in part due to concerns about US economic policy (e.g. heavy money printing by US in period of COVID lockdown) and the potential for sanctions that could hurt their economies (e.g. sanctions on Russia)

We can also see the below chart, which shows the declining % of USD in global forex reserves.

India is no exception to this de-dollarisation move. RBI has given permission to banks from 18 countries to open Special Vostro Rupee Accounts (SVRA) and use Indian rupees to settle payments. Renowned economist Nouriel Roubini, also known as 'Dr. Doom' by Wall Street, in February said that the Indian rupee over time could become one of the global reserve currencies in the world. China has also been stepping up the use of the Yuan as a trade settling mechanism. Last year, Yuan-denominated trade flows between Russia and China surged. Vladimir Putin said he supports using the Chinese Yuan for trade settlements between Russia, Asia, Africa and Latin America.

But it is not just about standalone countries, the BRICS ally is also reportedly exploring the creation of a common currency for trade amongst themselves. BRICS stands for Brazil, Russia, India, China and South Africa, which is an alliance of 5 powerful emerging countries. The BRICS countries represented 31.4% of the global GDP (2020), but its members hold less than 15% of the voting power at both the World Bank and the International Monetary Fund. This move by BRICS can also help it to gain influence in global market.

A new financial arrangement, seen with potential to translate into a common BRICS currency, could be announced as soon as August 2023 at the forthcoming BRICS summit in South Africa. The plan is to initially transition to using domestic currencies in transactions, and then explore the introduction and circulation of a digital or an alternative form of currency.

The potential challenge in the success of this move is the bilateral differences between India and China due to ongoing military standoffs along the Line of Actual Control between the two Asian giants. However, Babakov, the deputy chairman of the Russian parliament, the State Duma, believes that the BRICS leader’s summit will reveal preparedness to implement this particular initiative, with work on the project ongoing.

In conclusion, the dominance of the US dollar in global finance has led to many countries exploring ways to circumvent its usage. However, only time will tell if these initiatives will be successful in the long run.