Exchange rate policy of RBI, its objectives,Floating Exchange rate policy

1. EXCHANGE RATE POLICY OF RBI
Prof. Isha Jaiswal

2. Meaning of Exchange Rate
• The rate at which one unit of currency is converted
into the currency unit of another country is known as
the rate of exchange.
• In other words the rate at which one currency
exchanges for another currency is called the rate of
exchange.
• Hence, the rate of exchange for India is nothing but
the price of foreign currency expressed in terms of
Indian currency.

3. RBI Current Reference Rate
• INR / 1 USD : 68.5990
• INR / 1 Euro : 75.6784
• INR / 100 Jap. YEN : 61.0100
• INR / 1 Pound Sterling : 95.5721

4. Exchange Rate
• Rate of exchange reflects external value of domestic
currency.
• It is to be noted that the rate of exchange depends
upon the supply and demand of the foreign currency.
• It changes with the change in supply and demand
conditions in the foreign exchange market and the
change in the rate of exchange affects exports and
imports and thereby balance of trade of a country.

5. What is Depreciation of Rupee
When we say the price of dollar has increased, it means
that we have to pay more rupees for purchasing
dollar. In this case the external value of a rupee has
declined. This is known as depreciation of Rupee.

6. What is Appreciation of Rupee
When we say the price of dollar has decreased it
means that we have to pay less rupees for
purchasing a dollar. In this case the external
value of rupee has increased. This is Known as
appreciation of rupee.

7. Exchange Rate Policies
There are two ways the price of a currency can be
determined against another. They are basically:
1. Fixed Exchange Rate Policy
2. Freely floating Exchange Rate Policy

8. Fixed Exchange Rate Policy
• A fixed exchange rate is a country's exchange rate
regime under which the government or central bank
ties the official exchange rate to another country's
currency (or the price of gold).
• The purpose of a fixed exchange rate system is to
maintain a country's currency value within a very
narrow band. Also known as pegged exchange rate.

9. Fixed Exchange Rate Policy
• Fixed rates provide greater certainty for exporters and
importers. This also helps the government maintain
low inflation, which in the long run should keep
interest rates down and stimulate increased trade and
investment.
• It provides credibility, transparency, low
inflation and financial stability.

10. Fixed Exchange Rate Policy
If, for example, it is determined that the value of a single unit of
local currency is equal to US$3, the central bank will have to
ensure that it can supply the market with those dollars. In
order to maintain the rate, the central bank must keep a high
level of foreign reserves. This is a reserved amount of foreign
currency held by the central bank that it can use to release (or
absorb) extra funds into (or out of) the market. This ensures an
appropriate money supply, appropriate fluctuations in the
market (inflation/deflation) and ultimately, the exchange rate.
The central bank can also adjust the official exchange rate
when necessary.

11. Freely floating Exchange Rate
Policy
• A floating exchange rate is determined by the private
market through supply and demand.
• A floating rate is often termed "self-correcting," as
any differences in supply and demand will
automatically be corrected in the market.
• A floating exchange rate is constantly changing.
• Under the floating exchange rate policy, there is no
government intervention.
• It carries the risk of volatility and speculative
activities.

12. Objective of Exchange Rate Policy
of RBI
• To promote exports
• To Secure favorable terms of trade
• To protect rupee from fluctuations in the value of
foreign currencies.
• To attain plan targets in the sphere of foreign trade.

13. India’s Exchange Rate Policy
• India’s exchange rate policy has evolved over time in line with
the gradual opening up of the economy as part of the broader
strategy of macroeconomic reforms and liberalization since
the early 1990s.
• In the post independence period, India’s exchange rate policy
has seen a shift from a par value system to a basket-peg and
further to a managed float exchange rate system.

14. Exchange Rate Policy of RBI
• Par Value System (1947-1971)
• Pegged Regime (1971-1992)
• Liberalized Exchange Rate Management System
• Market Determined Exchange Rate System

15. Par Value System (1947-1971)
• Par Value system of exchange rate. Rupee’s external
par value was fixed in terms of gold with the pound
sterling as the intervention currency.
• Pound sterling was considered at that time as the
stable and strong reserve currency.

16. Pegged Regime (1971-1992)
• With the breakdown of the Bretton Woods System in 1971 due
to the suspension of convertibility of U.S. Dollar by U.S.
Government, the rupee was linked with U.S. dollar.
• In 1975 to ensure stability of the Rupee, and avoid the
weaknesses associated with a single currency peg, the Rupee
was pegged to a basket of currencies. Currency selection and
weight assignment was left to the discretion of the RBI and
not publicly announced.
• RBI allowed the domestic banks to undertake intra-day trading
in foreign exchange.

17. Liberalized Exchange Rate
Management System
• As trading volumes increased, the ‘Guidelines for
Internal Control over Foreign Exchange Business’
were framed in 1981.
• The foreign exchange market was still highly
regulated with several restrictions on external
transactions, entry barriers and transactions costs.
• Foreign exchange transactions were controlled
through the Foreign Exchange Regulations Act
(FERA).

18. Liberalized Exchange Rate
Management System (LERM)
• In July 1991,to stabilize the foreign exchange market, a two step
downward exchange rate adjustment was done (9% and 11%). This was a
decisive end to the pegged exchange rate regime.
• In March 1992, to ease the transition to a market determined exchange rate
system, the Liberalized Exchange Rate Management System (LERMS)
was put in place, which used a dual exchange rate system. This was mostly
a transitional system.
• In March 1993,he dual rates converted, and the market determined
exchange rate regime was introduced. All foreign exchange receipts could
now be converted at market determined exchange rates.

19. Changes in Exchange Rate of the
Rupee
Year Exchange Rate
in terms of
Dollar
1980-81 Rs. 7.91
1990-91 Rs. 17.94
1991-92 Rs. 24.47
March 1992 Rs. 25.89
March 2000 Rs.43.33
March 2003 Rs.48.39
March 2007 Rs. 44.03

20. Changes in Exchange Rate of the
Rupee
Since 1975, the rupee was depreciating due to:
• Deficits in India’s balance of payment.
• Liberal import policy
• Devaluation of rupee