Anda di halaman 1dari 24

Foreign

Exchange Rate
Policies in India
Contents
• Meaning of Foreign Exchange Rate
• BOP and Forex
• Terms
• Fixed exchange rate
• Flexible Exchange rate
• Evolution of Forex
• Exchange rate policy
• India’s Exchange rate policy- Chronology
Meaning of Exchange rate
• A rate at which the currency of one country is
converted into another currency is called “Exchange
Rate” or “Nominal Exchange Rate(NER)”.
• Real Exchange Rates:- The rate at which the goods
and services of one country is traded for the goods
and services of another country.
• Real Exchange rate= NER * Domestic Price
Foreign Price
Balance of Payment and
Exchange Rate
• Balance of Payment – the record of all
transactions of the residents with the rest of the
world
• Trade balance – Balance of exports and imports
of goods – exports are positive and imports are
negative
• Current account balance – Balance of trade in
goods, (trade balance), trade in services and
transfer payments
• Balance in services includes freight, royalty payments,
interest payments, dividend from assets abroad
• Transfer payments include remittances, gifts and grants
• Capital account balance – purchase and sale of assets
– stocks, bonds, land – purchase by Indians of assets
abroad is negative, purchase of assets by foreigners in
India (e.g., FDI) are positive
• Current account + Capital account = 0
• Increase in official reserves is called overall BOP surplus
Terms
 Devaluation – the price of foreign currencies under a fixed
exchange rate regime is increased by official action
 Revaluation - the price of foreign currencies under a fixed
exchange rate regime is decreased by official action

 Depreciation – under a floating rate system, price of foreign


currencies decreases because of market adjustment
 Appreciation - under a floating rate system, price of foreign
currencies decreases because of market adjustment
Fixed Exchange Rate
 In a fixed exchange rate system – foreign central
banks buy and sell their currencies at a fixed price in
terms of the domestic currency
 Prior to 1973, most countries had fixed exchange rates
against each other
 A fixed exchange rate acts like a price support system
 In order to maintain a fixed exchange rate, the central
bank has to make up for the excess demand or take up
the the excess supply of foreign currency.
Flexible Exchange Rate
 In a flexible exchange rate system, the central
bank allows the exchange rate to adjust to equate the
supply and demand for foreign currency. In effect
since 1973
 Clean floating – the central bank stands aside
completely and allows the exchange rate to be freely
determined in the forex market – official reserve
transactions are zero
 Managed float - the central bank intervenes to buy
or sell foreign currencies periodically in an attempt to
influence the exchange rates
Foreign Exchange Market
In India, the Foreign Exchange Market is a three-
level structure consisting of
(a)Reserve Bank of India(RBI) at the top
(b) Authorised Dealers licensed by RBI
(c) Customers (exporters, importers, companies and
other exchange earners).
The authorised dealers are governed by the
guidelines framed by the Foreign Exchange
Dealers Association of India(FEDAI).
Evolution of Foreign Exchange
PRE INDEPENDENCE:
• Exchange control was implemented in India on
September 3, 1939.
• The objective was mainly to regulate demand for
foreign exchange for various purposes, within the
limit set by the available supply.
• It lacked depth and liquidity.
POST INDEPENDENCE:
FERA (Foreign Exchange Regulation
Act),1947:
• Enacted by British regime as a temporary measure.
• The limited objective: To regulate the inflow of foreign
capital.
• During this period the exports was not picking up
while imports were high.
• The foreign exchange policy during the 1950’s was to
manage the exchange rate mainly for facilitating
India’s imports.
• The Bretton Woods System(1946-1971)
– Member countries need to fix the parities of their
currencies in terms US dollars or gold.
– The countries were obliged to keep fluctuations in
their currency within +/- 1% of the declared parity.
– IMF’s approval required to devaluate the currency.
– US $35= an ounce of gold
• Collapse of Bretton Woods System
– Persistent and very high American balance of
payments deficit.
– High inflation rate in USA in 1970-71
– Market perception-Insufficient gold reserves
by USA to massive supply of US dollars
– US announced on 15 august, 1971 not to
convert US $ into gold at the fixed rate as
committed to IMF
FERA(Foreign Exchange Regulation
Act0,1973:
• Government of India reviewed FERA, 1947 for
conserving foreign exchange rather than
regulating the entry of foreign capital.

• As a crisis-driven legislation, the FERA,1973


naturally contained several draconian
provisions. Any offence under FERA was a
criminal offence liable to imprisonment.
Foreign Exchange Management
Act(FEMA),1999:
• The main objective: To facilitate external trade
and payments and promote the orderly
development and maintenance of the foreign
exchange market in India.

• Law violators are treated as civil offenders rather


than criminals.
Foreign exchange policy initiatives since
1991
From the Floating system under which the
exchange rate was officially determined the
regime has passed through several phrases to
reach the present Market- based system under
which Exchange rate is determined by forces of
demand and supply.
Introduction of (LERMS),1992.
 LERMS – Liberalized Exchange Rate
Management System , partial convertibility of
the rupee was introduced in the form of a dual
exchange rate system
 The rate of exchange for conversion of 60% of
the proceeds of the transactions was the
market rate quoted by the Ads while
remaining 40% of the proceeds were
converted at the RBI’s official rate.
Exchange Rate Policy
Synchronization
 If policies are not synchronized between countries, they
may pose a major threat to free trade
 When import prices fall due to currency appreciation, large
shifts in demand will occur – domestic workers become
unemployed – leads to pressure for protection – tariff and
quotas
 Flexible exchange regime calls for more interdependence
than fixed exchange rate.
 Through international coordination of interests and policies,
the system works better
 Regular consultation between major currencies
Exchange rate of rupee with US $
India’s Exchange rate policy-
Chronology
Year

1947: Rupee tied to pound. Rs 1= 1s

18 September, Pound devalued; India maintained par with pound


1949

6 June, 1966 Rupee is devalued, Rs 4.76 = $1, after devaluation, Rs


7.50 = $1 (57.5%)
18 November, UK devalued pound, India did not devalue
1967

August 1971 Rupee pegged to gold/dollar, international financial crisis


Conti…
18 December, Dollar is devalued
1971

20 December, Rupee is pegged to pound sterling again


1971

1971-1979 The Rupee is overvalued due to India’s policy of import


substitution
23 June, 1972 UK floats pound, India maintains fixed exchange rate with
pound
1975 India links rupee with basket of currencies of major trading
partners. Although the basket is periodically altered, the link
is maintained until the 1991 devaluation.
July 1991 Rupee devalued by 18-19 %
March 1992 Dual exchange rate, LERMS, Liberalized Exchange Rate
Management System

March 1993 Unified exchange rate: $1 = Rs 31.37

1993/1994 Rupee is made freely convertible for trading, but not for
investment purposes
References
• Economic survey of India: 1947-48 to 2008-09 by
Dr. Chandra Shekhar Prasad.
• Sixty years of Indian economy:1947 to 2007
• Indian Currency system
• CMIE(Centre for Monitoring Indian Economy)
• www.economypedia.com
• Seniors
Thank You