Evolution of Exchange Management in India

The exchange rate is an important aspect of currency for every country. How a country’s currency measures up to other currencies in the world helps gain a better idea of how valued and devalued it is. Furthermore, this exchange rate is often a reflection of the country’s economy. Whether the country’s economic health is positive or negative – the exchange rate is quite telling. 

What is the Exchange Rate?

The exchange rate is the value of a currency in terms of a different currency. Many buyers and sellers are engaged in the foreign currency market, including students, commercial banks, brokers, and more. 

There are a couple of functions the foreign exchange fulfils. This includes:

• The foreign exchange rate is stabilised through the forward and spot market.
• Currency can be transferred from market to market as per the transactions made.
• The importers receive short-term credit, which helps facilitate a smooth flow of goods and services between many countries. 

Exchange Rate Regime and its Types 

The exchange rate regime is a country’s authority’s procedure in managing its currency. The country’s currency must be managed concerning other countries’ currencies and the foreign exchange market at large. The exchange rate regime is a critical element of every national economic policy framework. 

This is because the volume and speed of transactions in this regime are quite high. It’s no surprise the exchange rate regime has as large an impact on financial flows and world trade as it does. 

There are many types of exchange rate regimes. On the extremes are the free-floating and fixed exchange regimes. All other types fall in between these two. Both of these regimes are greatly dependent on impact and influence. They are also closely related to the monetary policy of the country.

Fixed exchange rate regimes have a higher level of international reserves and come with greater intervention by the monetary authorities. The intervention is done to keep the domestic currency’s value in terms of another currency at the same rate. 

On the other hand, a freely floating exchange rate regime has lower levels of international reserves, but there is less intervention by the monetary authorities. Therefore, the foreign exchange market largely operates on its own. 

Evolution of Exchange Rate Management in India

The evolution of exchange rate management in India is significant in India’s history. Following the Independence of India in 1947, the country employed a fixed exchange rate regime. Here, the Indian Rupee was pegged to the pound sterling. Eventually, come March 1993, the market-determined exchange rate regime was adopted instead. This is the regime that is still being followed in India. 

A timeline of this evolution has been given below.

Par Value System (1947-1971): Also known as the Bretton Woods system, this system was followed immediately after gaining independence. The rupee’s external par value with the par value system was fixed at 4.15 grains of fine gold. 

Pegged Regime (1971-1992): India pegged its currency to other currencies. From August 1971 to December 1971, the Indian Rupee was pegged to the US dollar. From December 1971 to September 1975, it was pegged to the Pound Sterling.

The following 1991: On July 1 and 3, 1991, a two-step downward adjustment was made to the exchange rate of the Indian Rupee. This was about 18-19%. 

Liberalised Exchange Rate Management System (LERMS, 1992): The finance minister announced this in the Budget for 1992-1993. This system allowed for the partial convertibility of the Indian Rupee. Furthermore, a dual exchange rate was put forward. 60% of the foreign exchange earnings would be converted according to the market-determined rate, while the remaining 40% would be surrendered at the official exchange rate. 

Unified Exchange Rate System (UERS, 1993): This system replaced LERMS only a year after its enforcement. The Indian Rupee was devalued by about 35% in nominal terms by the end. 

Current Regime Features

Now that we have taken a good look at the evolution of exchange rate management in India, let’s look at some of the key features of the current regime. 

• The principal currency for RBI transactions is the US Dollar.
• The market determines the rates of exchange.
• Receipts must be surrendered to the banks. In turn, they will meet and fulfil the present foreign exchange demand.
• The freely floating exchange rate regime still operates within the exchange control framework.
• The Reserve Bank of India has free rein to interfere in the market. They may regulate the devaluation of the Indian Rupee as well as its extreme volatility. Transactions are influenced at the exchange rate. These can change within 5% of the reigning market rate. 
• Finally, every day at noon, a Reference Rate is announced based on the banks’ quotations. This only applies to banks in Mumbai. Moreover, this reference rate only applies to transactions and SDR transactions through the Asia Clearing Union. 

Conclusion

The exchange rate regime is one of the most important regimes in the country. It determines the value of the Indian Rupee in terms of other currencies, such as the US Dollar, Pound Sterling, Euro, etc. The exchange rate management has undergone great evolution and changes over the years. As the times change and the years go by, this system will evolve even further.