. and whereas in the present disorganisation of the monetary systems of the world it is not possible to determine what will be suitable as a permanent basis for the indian monetary system …. ” 5. the floating exchange rate regime that came into existence in early 70 ’ s has remained in force for four and half decades. it is not that there has not been occasions of disorderliness and turbulence in the market but the regime has not been over turned. 6. three interrelated factors have contributed to the evolution of foreign exchange market as we see it now. first, there has been tremendous improvement in global communication infrastructure gone are the days when trading and settlement used to be done over telegraphic systems ( hence the term cable rate ). the modern communication network has reached the time and space gap and the only limitation now is the diurnal motion of the earth. secondly, this period also coincided with quantum advancement in computing capacity. this has helped in improving the communication network. but more importantly it has made trading and settlement quite easier. it is possible for the trader as well as the back office to instantaneously understand the implication of a trade. the ultimate culmination of this is of course “ algorithm trading ”. thirdly, along with the development in computation, sophisticated mathematical models have evolved to engineer complex and bespoke financial products. a combination of these three factors has brought about a foreign exchange market that is truly global, liquid and large. 7. notwithstanding the complexity and sophistication of the foreign exchange market, the fundamental principle remains simple yet profound. the foreign exchange market deals with currencies and a foreign currency is but a commodity vis - a - vis the domestic currency. the price is the exchange rate. any price has two determinants. the supply factor and the demand factor. the first can be seen to be derived from the cost of production and the second from the factors that affect demand, utility for instance. in the foreign exchange market, the first factor which ultimately determines the exchange rate in the long run is the purchasing power parity or the inflation differential. the second factor that causes exchange rate movement in the short run is the expected earnings from exchange rate dynamics. in the simplest of cases it is derived from interest rate differential but in the real world the exchange rate demonstrates random walk and behaves like any other financial asset. it will be important here to remember that both the factors play equally important role in determination of the price. to quote alfred

, another crisis in the nature of sovereign debt crisis surfaced. the growing debts of many european sovereigns caused sustainability concerns forcing investors to withdraw from these markets which led to significant escalation of their cds spreads. the crisis which emerged in late 2009 has engulfed the entire eurozone by end 2011. while only greek bonds had cds spreads higher than 200 bps in april 2010, by jan 2012, bonds of all countries except germany, finland and the netherlands had cds spreads higher than 200 bps. in fact, bonds of piigs countries ( portugal, italy, ireland, greece and spain ) had cds spreads even higher than 400 bps. the combination of sluggish activity, bailouts and fiscal stimulus measures have led to ballooning of fiscal deficits and public debt / gdp ratios in major advanced economies and have raised concerns over fiscal sustainability. these concerns are most visible in euro area countries, which were plagued by various combinations of problems such as over - large banking sector that had become exposed to a housing boom and bust, an uncompetitive economy signaled by repeated current account deficits, and a bloated state sector with high private - sector unemployment 6. for example, fiscal deficit / gdp ratios of advanced economies jumped from a near balance position ( deficit of 0. 6 per cent ) in 2007 to 9. 0 per cent in 2009, with that of the us jumping from 2. 7 per cent to 13. 0 per cent over the same period. fiscal deficits of emerging economies also rose, albeit relatively modestly, from a surplus of 0. 1 per cent in 2007 to a deficit 4. 8 per cent in 2009. the public debt / gdp ratio for advanced economies increased from 73. 4 per cent in 2007 to 93. 7 per cent in 2009 and further to 103. 5 per cent in 2011. the ratios for emerging market economies ( emes ) over the same years were almost unchanged at 35. 9 per cent, 36. 7 per cent and 37. 8 per cent. the sovereign debt crisis, in a way has completed the circle – during the global crisis 2007 the impact spread from banking system to sovereigns while in the current crisis, the impact is in the reverse direction, from sovereigns to banks. what makes the present crisis more disturbing is, in the global crisis, when banks were under stress there was a backstop in the nature of sovereigns, but now sovereigns themselves are on the verge of default leaving everyone wonder as to what could