Exchange Rate Policy in India By: A policy reaction function tests for its intervention behaviour and finds significant effort to lean against the wind during This indicates a real exchange rate stabilisation policy by the Indian authorities.
Related to the problem of balance of payments is the macro issue of foreign exchange rate. The balance of payments is influenced by the foreign exchange rate. Exchange rate is the value of national currency in terms of a foreign currency.
Thus, currently September 20, one US dollar is exchanged for around Rs. Changes in foreign exchange rate affect the prices of exports and imports which in turn determine their volume and thereby determine balance of payments of a country.
Since exchange rate is a price, its determination can be explained through demand for and supply of foreign exchange.
However, in the long run the foreign exchange rate between the two currencies is determined by the purchasing powers of the two currencies in the domestic economies.
In the short run, the demand for imports and exports of goods and services that is, both visible and invisible itemsmagnitude of capital flows between the countries affects demand for and supply of foreign exchange and thereby determine the exchange rate between the currencies.
The system of exchange rate in which the value of a currency is allowed to adjust freely or to float as determined by demand for and supply of foreign exchange is called a flexible exchange rate system.
The flexible exchange rate system is also called floating exchange system. At present, in most of the countries of the world including Indiathe flexible exchange rate system prevails. On the other hand, if foreign exchange rate, instead of being determined by demand for and supply of foreign exchange, is fixed by the government, it is called the fixed exchange rate system which prevailed in the world under an agreement reached at Bretton Woods in New Hampshire in July Therefore, fixed exchange rate is also often called Bretton Woods System.
Under the Bretton Woods fixed exchange rate system, exchange rate is not determined by demand for and supply of foreign exchange but is pegged at a certain rate.
At the fixed exchange rate, if there is disequilibrium in the balance of payments giving rise to either excess demand or excess supply of foreign exchange, the Central Bank of the country has to buy or sell the required quantifies of foreign exchange to eliminate the excess demand or supply.
But in the mid seventies Bretton Woods system of fixed exchange rate system in which US dollar played a key role collapsed as the USA could not keep constant the price of US dollar in terms of gold. In a fixed exchange rate system the government has to buy or sell foreign exchange in order to maintain the rate at the controlled level.
For instance, in Junethe value of rupee in terms of US dollar and U.
Again in July India reduced its value of rupee in terms of US dollar by about 20 per cent. Such a one-time lowering of value of its currency in terms of foreign exchange occasionally by a country is called devaluation as distinguished from depreciation which under flexible exchange rate system can often take place under the influence of changes in demand for and supply of a currency.
On the other hand, with a fixed rate exchange system if a country raises the value of its currency in terms of foreign currency, it is called revaluation. It should be noted that since March India has adopted flexible exchange rate system and has also now made its rupee convertible into a foreign currency.
In fact, at present the Indian rupee can appreciate or depreciate every day depending on the demand for and supply of US dollar and other foreign currencies and demand for and supply of the Indian rupee.
Changes in foreign exchange rate have an important effect on the balance of payments of a country. When there is depreciation or devaluation in the currency of a country, its exports become cheaper and imports costlier than before.
This causes exports to increase and imports to decrease causing reduction in deficit in balance of payments. Thus in order to check increase in deficit in balance of payment and to restore equilibrium in it, devaluation or depreciation of the domestic currency against foreign currencies is often undertaken.
Besides, the foreign exchange inflows in various forms such as those resulting from rising exports, portfolio investment by FIIs Foreign Institutional Investorsforeign direct investment FDI not only causes appreciation of exchange rate of the domestic currency but also leads to the increase in money supply in the economy and therefore inflationary situation in the country.
Thus higher appreciation in the value of rupee against US dollar in in India was the direct result of large capital inflows in India. The price of Indian rupee against US dollar rose from around Rs. This appreciation of rupee was driven by foreign exchange inflows partly by rising software exports but more importantly inflows by FIIs coming in large quantity to take advantage of the stock market boom in India.
Besides, foreign exchange inflows through NRI deposits lured by higher interest rates in India than those prevailing in their country of residence took place. Further, large capital inflows through foreign direct investment FDI in India also increased in and These large inflows of foreign exchange in India through its effect on the supply of dollars in foreign exchange market would have caused a very high appreciation of rupee vis-a-vis US dollar but RBI did buy some dollars from market from time to time to prevent it and built up reserves of foreign exchange.
But RBI could not buy dollars as fast as the large inflows came in. This resulted in appreciation of rupee in RBI could not ensure foreign exchange rate stability in situation of large capital inflows by buying sufficient amount of dollars from the market. The value of Indian rupee which was Rs.
To prevent excessive depreciation of the Indian rupee RBI intervened and sold US dollars from its foreign exchange reserves. Further from May FIIs started withdrawing capital from debt market and capital markets as a result of which demand for US dollars rose for sending it for investment in the US.
This was triggered by the statement of the governor Ben Bernanke of the US Federal Reserve that as the US economy had revived; it would start unwinding the quantitative easing QE which was adopted to give stimulus to the US economy.
This led to capital outflows from the emerging economies including India to the US. In the months of May and June about 9 billion US dollars were withdrawn from India and contributed to capital outflows from India. Thus large capital outflows by FIIs and large current account deficit CAD led to the sharp depreciation of the value of Indian rupee which was around Rs.In short, the India rupee has matured to a regime of the floating exchange rate from the earlier versions of a ‘managed float’.
Convertibility on Current Account: The current regime of the exchange rate has been accompanied by full ‘Convertibility on current account with effect from August 20, Therefore, floating exchange rate regimes enhance market efficiency.
Greater insulation from other countries’ economic problems: Under a fixed exchange rate regime, countries export their macroeconomic problems to other countries.
Suppose that the inflation rate in the U.S. is rising relative to that of the Euro-zone. “managed float exchange rate regime is followed by india” Meaning of Fixed Exchange rate: A fixed exchange rate, sometimes called a pegged exchange rate, is also referred to as the Tag of particular Rate, which is a type of exchange rate regime where a currency’s value is fixed against the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.
This article provides an essay on foreign exchange rate in India.
Introduction: Related to the problem of balance of payments is the macro issue of foreign exchange rate. The balance of payments is influenced by the foreign exchange rate.
Exchange rate is the value of national currency in terms of a foreign currency. Real Exchange Rate Stabilisation and Managed Floating: Exchange Rate Policy in India, Renu Kohli* The paper examines the exchange rate management strategy of the Indian central bank after the shift to a.
Fixed versus floating exchange rates Introduction The exchange rate regime The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market.