Exchange rate policy in india ppt

Discusses evolution of Exchange rate management system in India.

1. Exchange Rate Policy in India Sonam Sangwan Assistant Professor, Economics GCW Bawani Khera

2. Introduction Exchange rate refers to the price of a nation’s currency in terms of another nation’s currency. Exchange rate is an important factor that determines the country’s economic condition. It allows the country to trade with other countries. There are mainly two types of exchange rate systems- Flexible Exchange rate system Fixed Exchange rate system. In a flexible exchange rate system, the currency’s value is allowed to fluctuate according to the foreign exchange market. But, in a fixed exchange rate system, the value of the currency is fixed against the value of another currency or to gold. Currently, India maintains a floating exchange rate system, which is a hybrid of the fixed and floating exchange rate systems.

3. Historical Background Since Independence, the exchange rate system in India has transited from a fixed exchange rate regime to the present form of market-determined exchange rate regime. The period of evolution of exchange management from 1947 to the present times has been divided into three main parts: Par Value System (1947-1971) Pegged Regime (1971-1992) Liberalised Exchange Rate Management System

4. Par Value System (1947-1971) During this time period, India followed a fixed exchange rate system under the Bretton Woods System .  Under this system, the gold exchange standard was introduced. The United States was to maintain the price of gold fixed at 35 dollars per ounce and was supposed to exchange dollars for gold at that price without restrictions or limitations. Other nations were required to fix the price of their currencies directly in terms of dollars and indirectly in terms of gold. The exchange rate could fluctuate within plus or minus 1 percent around the agreed par value. Therefore, the Indian Rupee’s external par value was fixed in terms of gold. The devaluation of Rupee in 1966 in terms of gold, resulted in the reduction of the par value of Rupee. But from 1966 to 1971, the exchange rate of Rupee remained unchanged. This par value system of exchange rate was followed till 1971 till the breakdown of the Bretton Woods system , post which most of the currencies adopted floating systems.

5. Pegged Regime (1971-1992) With the breaking down of the Bretton Woods system , India moved towards the pegged exchange rate system. The Indian Rupee was linked to U.K. Pound Sterling.   However, although a currency peg can minimize fluctuation, at the same time it increases the imbalances between the countries. Therefore, in 1975, Rupee was pegged to a basket of currencies. This was done to ensure the stability of Rupee and avoid weaknesses associated with a single currency peg. During 1990 and 1991, India faced a major Balance of Payment ( BoP ) crisis . The Soviet Union was an important trade partner of India in 1960s. As the Soviet Union started to crack in the 1980s, India’s exports went down significantly. Also, due to the Gulf crisis in 1990, the prices of crude oil (an important import to India) rose significantly. These are the two of many reasons that led India to the BoP crisis in 1991. Therefore, India was forced to borrow money from the International Monetary Fund (IMF) against the country’s gold reserves. As a result of the BoP crisis, foreign exchange reserves had fallen to low levels that weren’t enough to pay for even a month of imports. The policymakers discussed various ways to deal with the crisis that eventually led to liberalization of the economy.

6. Liberalised Exchange Rate Management System There was a two-step devaluation of Rupee in 1991 by the RBI which ended the pegged exchange rate system and marked the beginning of the market determined exchange rate system. The Liberalized Exchange Rate Management System (LERMS) was introduced to ease the transition from one system to another. LERMS began from March 1, 1992. Under this system, Rupee was made partially convertible . This partial convertibility of Rupee is known as the dual exchange (60:40 ratio) system. Since India was going through a period of deficit, it was risky to impose full convertibility of the Rupee. LERMS was set up to boost the foreign exchange earnings to improve the BoP .

7. Continued… Since LERMS was only a transitional mechanism, it was removed in 1993 and the market exchange rate system was introduced. That means that the 60:40 ratio was removed and 100% of the foreign exchange receipt was now converted at the market based exchange rate. Also, in 1994, the current account was made fully convertible . Thus when Rupee became a floating currency, the current account of India was made fully convertible, but the capital account was only partially convertible. This was done to protect the domestic market from foreign competition . After the recommendations of the S.S. Tarapore Committee (1997) on Capital Account Convertibility, India has been moving in the direction of allowing full convertibility in this account, but with required precautions.

8. Thank you…. ☻