Foreign exchange market is the market in which foreign currencies are bought and sold. Being a member of the IMF, India followed the par value system of the pegged exchange rate system. But when the Bretton Woods system collapsed in 1971, the rupee was pegged to pound sterling for four years after which it was initially linked to the basket of 14 currencies but later reduced to 5 currencies of India’s major trading partners. Currently India has adopted the managed exchange rate system.

• In 1967, gold was displaced by creating the Special Drawing Rights (SDRs), also known as ‘paper gold’, in the IMF as a replacement to gold as an international reserve standard.
• However, SDRs were defined in terms of gold.
• At present, it’s determined day by day as the weighted amount of the qualities in dollars of five monetary standards (euro, dollar, Japanese yen, pound sterling,chinese renminbi). 
• The strength of it derived from IMF members who were willing to use it as a reserve currency and use it as a payment means between central banks to exchange for national currencies. 
• The original installments of SDRs were distributed to member countries in accordance with their quota within the Fund (the quota was broadly associated with the country’s economic importance as indicated by the value of its international trade). 

Slowly many countries began to adopt the floating exchange rates, and the IMF gave the freedom to countries to decide, if they wanted to go for a floating market determined exchange rate, or peg (tie the exchange rate) their currencies to a particular asset like the SDR. 

The Current Scenario: 

• Today, the global exchange rate system is characterized by multiple kinds of regimes, involving free floating exchange rates, pegging their exchange rates to other developed countries, introducing common currencies like Euro etc.   
• Most exchange rates fluctuate slightly on a day to day basis, with even those nations tilting towards fixed exchange rate systems, only specifying a certain range for their currency instead of actually fixing them. 
• Gold is now not being used for exchange rate purposes, instead the prices of gold are controlled by demand and supply. 
  
  

Exchange Rate Management in India: 

• Post-independence, in line with Bretton Woods system Rupee was pegged to the pound sterling. 
• The rupee had been devalued by 36.5 per cent in June 1966. 
• The rupee was delinked from the pound sterling in September 1975, due to the breakdown of Bretton Woods system and declining share of UK in India’s trade.  
• During the years between 1975 to 1992, the pace of trade of the rupee was authoritatively dictated by the Reserve Bank inside an ostensible band of give or take 5% of the weighted crate of monetary standards of India’s significant exchanging accomplices.
• Requiring day-to-day intervention of the Reserve Bank, which resulted in wide changes in the size of reserves. 
• The exchange rate regime of this period can be denoted as an adjustable nominal peg with a band. 
• In the beginning of 1990s, the situation for India became problematic requiring reforms in line with IMF recommendations (explained in class 11th Notes).   
• Along with other reforms there was a two-step devaluation of 1 8 –19 percent of the rupee on July 1 and 3, 1991. 
• In March 1992, the Liberalized Exchange Rate Management System (LERMS) which involves dual exchange rates was introduced. 
• Under this system, 40 percent of exchange earnings had to be surrendered at an official rate which had been determined by the Reserve Bank and 60 per cent was to be converted at the market determined rates.
• The dual rates were converged into one and only rate from March 1, 1993. 
• Current account convertibility was achieved in August 1994. Meaning that the Rupee could now be converted into any foreign currency at existing market rates for trade purposes for any amount. 
• The rate of exchange of the rupee thus became market determined, with the Reserve Bank ensuring orderly conditions in the foreign exchange market through its sales and purchases.

Conclusion–

Since Independence, the exchange rate system in India has transited from a fixed exchange rate regime where the Indian rupee was pegged to the pound sterling on account of historic links with Britain to a basket-peg during the 1970s and 1980s and eventually to the present form of market-determined exchange rate regime since March 1993.