The document outlines the evolution of global exchange rate systems, starting with the Bretton Woods system (1944-1971) which established fixed exchange rates pegged to the U.S. dollar linked to gold. After its collapse in 1971, most economies adopted floating exchange rates, leading to the growth of the forex market. The document also discusses India's exchange rate history post-independence, including various pegging strategies and the impact of economic reforms leading to a managed floating exchange rate since 1993.

1. EXCHANGE RATES

2. THE BRETTON WOODS SYSTEM (1944–1971)
• POST-WAR AGREEMENT (1944): AFTER WORLD WAR II, THE GLOBAL ECONOMY NEEDED A
NEW FRAMEWORK FOR CURRENCY EXCHANGE. THE BRETTON WOODS CONFERENCE
ESTABLISHED A NEW SYSTEM WHERE MOST CURRENCIES WERE PEGGED TO THE U.S. DOLLAR,
WHICH WAS IN TURN LINKED TO GOLD AT A FIXED RATE OF $35 PER OUNCE.
• FIXED EXCHANGE RATES: UNDER BRETTON WOODS, COUNTRIES MAINTAINED FIXED
EXCHANGE RATES BY BUYING OR SELLING THEIR OWN CURRENCY AGAINST THE DOLLAR.
THIS SYSTEM CREATED STABILITY AND ENCOURAGED INTERNATIONAL TRADE AND
INVESTMENT.
• COLLAPSE OF BRETTON WOODS (1971): RISING U.S. INFLATION AND THE COST OF THE
VIETNAM WAR STRAINED THE U.S. DOLLAR’S ABILITY TO MAINTAIN ITS LINK TO GOLD. IN
1971, PRESIDENT RICHARD NIXON ANNOUNCED THE SUSPENSION OF GOLD CONVERTIBILITY,
EFFECTIVELY ENDING THE BRETTON WOODS SYSTEM AND LEADING TO THE ERA OF
FLOATING EXCHANGE RATES.

3. FLOATING EXCHANGE RATES (1973–PRESENT)
• FREE-FLOATING EXCHANGE RATES (1973): AFTER THE COLLAPSE OF THE BRETTON WOODS
SYSTEM, MOST MAJOR ECONOMIES MOVED TO A FLOATING EXCHANGE RATE SYSTEM,
WHERE CURRENCIES ARE TRADED IN THE FOREIGN EXCHANGE (FOREX) MARKET, AND THEIR
VALUES ARE DETERMINED BY SUPPLY AND DEMAND.
• CURRENCY PEGS: DESPITE THE RISE OF FLOATING EXCHANGE RATES, SOME COUNTRIES
OPTED TO MAINTAIN FIXED OR PEGGED EXCHANGE RATES, OFTEN TO THE U.S. DOLLAR OR
THE EURO, TO STABILIZE THEIR ECONOMIES. EXAMPLES INCLUDE THE HONG KONG DOLLAR
AND THE SAUDI RIYAL.
• FOREX MARKET GROWTH: THE 1970S AND 1980S SAW THE RAPID EXPANSION OF THE
FOREX MARKET, WHERE TRILLIONS OF DOLLARS ARE TRADED DAILY. CENTRAL BANKS
OCCASIONALLY INTERVENE TO STABILIZE THEIR CURRENCIES, BUT MOST DEVELOPED
NATIONS NOW ALLOW THEIR EXCHANGE RATES TO BE DETERMINED BY MARKET FORCES.

4. PRE-INDEPENDENCE PERIOD (BEFORE 1947)
• SILVER STANDARD ERA (1800S–1890S): INDIA USED THE SILVER STANDARD FOR ITS
CURRENCY, WHERE THE VALUE OF THE INDIAN RUPEE (INR) WAS TIED TO THE PRICE OF
SILVER. WITH GLOBAL FLUCTUATIONS IN SILVER PRICES, THE RUPEE'S VALUE WAS
UNSTABLE COMPARED TO CURRENCIES ON THE GOLD STANDARD, SUCH AS THE BRITISH
POUND. GOLD EXCHANGE
• STANDARD (1898–1931): IN 1898, INDIA ADOPTED A GOLD EXCHANGE STANDARD. THE
RUPEE WAS LINKED TO THE BRITISH POUND, WHICH WAS TIED TO GOLD. THE EXCHANGE
RATE WAS FIXED AT 1 POUND = 13.33 INR. THIS STABILIZED INDIA'S EXCHANGE RATE
FOR A FEW DECADES.
• DEPRESSION ERA (1931–1947): DUE TO THE GREAT DEPRESSION AND BRITAIN
ABANDONING THE GOLD STANDARD, THE INDIAN RUPEE ALSO LOST ITS GOLD BACKING.
THE RUPEE WAS DEVALUED SEVERAL TIMES, AND ITS EXCHANGE RATE FLUCTUATED.

5. POST-INDEPENDENCE (1947–1991)
• FIXED EXCHANGE RATE REGIME (1947–1966): AFTER INDEPENDENCE IN 1947, THE
INDIAN RUPEE WAS PEGGED TO THE BRITISH POUND AT A RATE OF 1 POUND = 13.33
INR. HOWEVER, WITH THE ECONOMIC CHALLENGES, INDIA DEVALUED ITS CURRENCY IN
1966 BY 36.5%, RESULTING IN 1 POUND = 21 INR.
• U.S. DOLLAR PEG (1971–1975): INDIA MOVED FROM THE BRITISH POUND TO THE U.S.
DOLLAR PEG AFTER THE BRETTON WOODS SYSTEM COLLAPSED. FROM 1971 TO 1975,
THE EXCHANGE RATE OF 1 USD = 7.5 INR WAS MAINTAINED.
• BASKET PEGGING (1975–1991): FROM THE MID-1970S, INDIA SWITCHED TO A
MANAGED FLOATING EXCHANGE RATE SYSTEM, ALLOWING LIMITED FLEXIBILITY FOR THE
RUPEE WHILE IT WAS LOOSELY PEGGED TO A BASKET OF MAJOR CURRENCIES, PRIMARILY
THE U.S. DOLLAR.

6. LIBERALIZATION PERIOD (1991–PRESENT)
• ECONOMIC CRISIS AND DEVALUATION (1991): DUE TO A SEVERE BALANCE OF
PAYMENTS CRISIS, INDIA WAS FORCED TO DEVALUE THE RUPEE IN 1991. THIS
DEVALUATION, ALONGSIDE ECONOMIC REFORMS, LED TO A SHIFT FROM A FIXED TO A
MARKET-DETERMINED EXCHANGE RATE SYSTEM.
• PARTIAL CONVERTIBILITY (1992–1993): INDIA INTRODUCED A DUAL EXCHANGE RATE
SYSTEM IN 1992. UNDER THIS SYSTEM, PART OF FOREIGN EXCHANGE EARNINGS WERE
CONVERTED AT MARKET RATES AND PART AT OFFICIAL RATES. IN 1993, THE SYSTEM WAS
UNIFIED, MAKING THE RUPEE LARGELY CONVERTIBLE ON THE CURRENT ACCOUNT.
• FLOATING EXCHANGE RATE (1993–PRESENT): SINCE 1993, INDIA HAS FOLLOWED A
MANAGED FLOATING EXCHANGE RATE SYSTEM, WHERE THE RUPEE'S VALUE IS
DETERMINED BY MARKET FORCES WITH OCCASIONAL INTERVENTION BY THE RESERVE
BANK OF INDIA (RBI) TO STABILIZE EXTREME VOLATILITY.

7. DUAL EXCHANGE RATE MECHANISM
THE 60:40 DUAL EXCHANGE RATE MECHANISM REFERS TO A SYSTEM INDIA
ADOPTED DURING THE ECONOMIC REFORMS IN THE EARLY 1990S TO MANAGE
ITS BALANCE OF PAYMENTS CRISIS AND FACILITATE A SMOOTHER TRANSITION
TO A MARKET-DETERMINED EXCHANGE RATE. THIS MECHANISM WAS PART OF
THE LIBERALIZED EXCHANGE RATE MANAGEMENT SYSTEM (LERMS), WHICH
WAS INTRODUCED BY THE RESERVE BANK OF INDIA (RBI) IN 1992 AS A
TEMPORARY SOLUTION.

8. TWO EXCHANGE RATE MECHANISM
• UNDER LERMS, THERE WERE TWO EXCHANGE RATES IN THE MARKET: AN
OFFICIAL GOVERNMENT-DETERMINED EXCHANGE RATE AND A MARKET-
DETERMINED EXCHANGE RATE.
• 60% OF FOREIGN EXCHANGE EARNINGS (FROM EXPORTS, REMITTANCES, ETC.)
HAD TO BE SURRENDERED TO THE GOVERNMENT OR RBI AT THE OFFICIAL
EXCHANGE RATE.
• THE REMAINING 40% COULD BE CONVERTED AT THE PREVAILING MARKET-
DETERMINED EXCHANGE RATE.

9. THE EURO AND CURRENCY UNIONS (1999–PRESENT)
• THE EURO (1999): THE INTRODUCTION OF THE EURO IN 1999 MARKED A MAJOR
DEVELOPMENT IN CURRENCY EXCHANGE HISTORY. THE EURO REPLACED MULTIPLE
NATIONAL CURRENCIES IN THE EUROPEAN UNION (EU) AND IS NOW ONE OF THE
WORLD’S MOST TRADED CURRENCIES.
• CURRENCY UNIONS AND PEGS: SEVERAL COUNTRIES AROUND THE WORLD STILL USE
PEGGED EXCHANGE RATES OR ARE PART OF CURRENCY UNIONS. SOME DEVELOPING
NATIONS OR SMALLER ECONOMIES PEG THEIR CURRENCIES TO STRONGER CURRENCIES
LIKE THE U.S. DOLLAR OR THE EURO TO MAINTAIN STABILITY.

10. MODERN ERA AND DIGITAL CURRENCY
• DIGITAL CURRENCIES: IN RECENT YEARS, THE RISE OF CRYPTOCURRENCIES LIKE BITCOIN HAS
INTRODUCED A NEW FORM OF DECENTRALIZED, DIGITAL EXCHANGE. WHILE NOT YET A
MAINSTREAM FORM OF CURRENCY EXCHANGE, DIGITAL CURRENCIES ARE GAINING ATTENTION
AS ALTERNATIVES TO TRADITIONAL SYSTEMS.
• SPECIAL DRAWING RIGHTS (SDRS): THE INTERNATIONAL MONETARY FUND (IMF) HAS DEVELOPED
SDRS, WHICH ACT AS AN INTERNATIONAL RESERVE ASSET AND ARE USED BY COUNTRIES TO
SUPPLEMENT OFFICIAL RESERVES. SDRS ARE BASED ON A BASKET OF MAJOR CURRENCIES,
INCLUDING THE U.S. DOLLAR, EURO, CHINESE YUAN, JAPANESE YEN, AND BRITISH POUND.

11. APPRECIATION AND DEPRECIATION OF A
CURRENCY
• APPRECIATION AND DEPRECIATION OF A CURRENCY REFER TO CHANGES IN
THE VALUE OF A CURRENCY RELATIVE TO OTHER CURRENCIES IN THE FOREIGN
EXCHANGE MARKET.
• THESE TERMS APPLY TO CURRENCIES UNDER A FLOATING EXCHANGE RATE
SYSTEM, WHERE MARKET FORCES DETERMINE CURRENCY VALUES BASED ON
SUPPLY AND DEMAND.

12. CURRENCY APPRECIATION
• CURRENCY APPRECIATION OCCURS WHEN A CURRENCY'S VALUE INCREASES RELATIVE TO
ANOTHER CURRENCY.
• IN OTHER WORDS, WITH THE SAME AMOUNT OF THE APPRECIATING CURRENCY, YOU CAN
NOW BUY MORE UNITS OF A FOREIGN CURRENCY OR MORE FOREIGN GOODS AND SERVICES
• EXAMPLE OF CURRENCY APPRECIATION:
• IF 1 USD WAS INITIALLY EQUAL TO 75 INR, AND LATER IT BECOMES EQUAL TO 70 INR, THIS
MEANS THE INDIAN RUPEE (INR) HAS APPRECIATED RELATIVE TO THE US DOLLAR (USD). NOW,
FEWER INR ARE REQUIRED TO BUY 1 USD, INDICATING THAT THE RUPEE'S PURCHASING POWER
HAS INCREASED IN RELATION TO THE DOLLAR.

13. CAUSES OF CURRENCY APPRECIATION:
• HIGHER INTEREST RATES: IF A COUNTRY'S CENTRAL BANK RAISES INTEREST RATES, IT ATTRACTS
FOREIGN CAPITAL, AS INVESTORS SEEK HIGHER RETURNS. THIS INCREASES DEMAND FOR THE
CURRENCY, CAUSING IT TO APPRECIATE.
• IMPROVED ECONOMIC CONDITIONS: A GROWING ECONOMY WITH STRONG ECONOMIC
INDICATORS (GDP GROWTH, LOW INFLATION, STABLE GOVERNMENT POLICIES) CAN ATTRACT
FOREIGN INVESTMENT, LEADING TO CURRENCY APPRECIATION.
• TRADE SURPLUSES: IF A COUNTRY EXPORTS MORE THAN IT IMPORTS, THERE IS INCREASED
DEMAND FOR ITS CURRENCY, CAUSING APPRECIATION.
• SPECULATION: IF INVESTORS EXPECT A CURRENCY TO RISE IN VALUE IN THE FUTURE, THEY MAY
BUY THE CURRENCY NOW, INCREASING ITS DEMAND AND CAUSING APPRECIATION.

14. EFFECTS OF CURRENCY APPRECIATION:
• CHEAPER IMPORTS: AS THE DOMESTIC CURRENCY APPRECIATES, IMPORTED GOODS AND SERVICES
BECOME CHEAPER, LEADING TO A LOWER COST OF LIVING FOR CONSUMERS AND REDUCED INPUT
COSTS FOR BUSINESSES.
• DECREASED EXPORT COMPETITIVENESS: A STRONGER DOMESTIC CURRENCY MAKES EXPORTS
MORE EXPENSIVE IN FOREIGN MARKETS, POTENTIALLY REDUCING DEMAND FOR A COUNTRY'S
GOODS ABROAD AND HURTING EXPORT INDUSTRIES.
• LOWER INFLATION: SINCE IMPORTS BECOME CHEAPER WITH AN APPRECIATING CURRENCY,
INFLATIONARY PRESSURES MAY DECREASE, AS THE COST OF IMPORTED GOODS AND SERVICES
DROPS.

15. CURRENCY DEPRECIATION
• CURRENCY DEPRECIATION OCCURS WHEN A CURRENCY'S VALUE DECREASES RELATIVE TO
ANOTHER CURRENCY. THIS MEANS IT TAKES MORE UNITS OF THE DEPRECIATING CURRENCY TO
BUY A GIVEN AMOUNT OF A FOREIGN CURRENCY.
• EXAMPLE OF CURRENCY DEPRECIATION:
• IF 1 USD WAS INITIALLY EQUAL TO 70 INR, AND LATER IT BECOMES EQUAL TO 75 INR, THIS
MEANS THE INDIAN RUPEE (INR) HAS DEPRECIATED RELATIVE TO THE US DOLLAR (USD).
MORE INR ARE REQUIRED TO BUY 1 USD, INDICATING THAT THE RUPEE'S PURCHASING POWER
HAS FALLEN IN RELATION TO THE DOLLAR.

16. CAUSES OF CURRENCY DEPRECIATION:
• LOWER INTEREST RATES: IF A COUNTRY LOWERS ITS INTEREST RATES, INVESTORS MAY SEEK
HIGHER RETURNS ELSEWHERE, REDUCING DEMAND FOR THE CURRENCY AND CAUSING
DEPRECIATION.
• WEAK ECONOMIC CONDITIONS: ECONOMIC SLOWDOWNS, HIGH UNEMPLOYMENT, OR
POLITICAL INSTABILITY MAY CAUSE INVESTORS TO LOSE CONFIDENCE IN A COUNTRY'S
ECONOMY, LEADING TO CAPITAL OUTFLOWS AND DEPRECIATION OF THE CURRENCY.
• TRADE DEFICITS: IF A COUNTRY IMPORTS MORE THAN IT EXPORTS, IT CREATES A HIGHER
DEMAND FOR FOREIGN CURRENCIES (TO PAY FOR IMPORTS) THAN FOR THE DOMESTIC
CURRENCY, LEADING TO DEPRECIATION.
• SPECULATION: IF INVESTORS BELIEVE THAT A CURRENCY WILL FALL IN VALUE IN THE FUTURE,
THEY MAY SELL IT IN ANTICIPATION, CAUSING THE CURRENCY TO LOSE VALUE IN THE PRESENT.

17. EFFECTS OF CURRENCY DEPRECIATION:
• MORE EXPENSIVE IMPORTS: A DEPRECIATING CURRENCY MAKES IMPORTS MORE EXPENSIVE,
LEADING TO HIGHER COSTS FOR CONSUMERS AND BUSINESSES. THIS CAN INCREASE
INFLATIONARY PRESSURES.
• IMPROVED EXPORT COMPETITIVENESS: A WEAKER CURRENCY MAKES A COUNTRY’S
EXPORTS CHEAPER AND MORE COMPETITIVE IN INTERNATIONAL MARKETS, POTENTIALLY
BOOSTING DEMAND FOR EXPORTS AND IMPROVING THE TRADE BALANCE.
• HIGHER INFLATION: SINCE IMPORTS BECOME MORE EXPENSIVE, INFLATION MAY RISE,
PARTICULARLY IF A COUNTRY RELIES HEAVILY ON IMPORTED GOODS AND RAW MATERIALS.

18. NOMINAL AND REAL EXCHANGE RATE
• THE NOMINAL EXCHANGE RATE IS THE RELATIVE PRICE OF THE CURRENCIES OF TWO
COUNTRIES. FOR EXAMPLE, IF THE EXCHANGE RATE BETWEEN THE U.S. DOLLAR AND THE
JAPANESE YEN IS 120 YEN PER DOLLAR, THEN YOU CAN EXCHANGE ONE DOLLAR FOR 120
YEN IN WORLD MARKETS FOR FOREIGN CURRENCY.
• A JAPANESE WHO WANTS TO OBTAIN DOLLARS WOULD PAY 120 YEN FOR EACH DOLLAR HE
BOUGHT. AN AMERICAN WHO WANTS TO OBTAIN YEN WOULD GET 120 YEN FOR EACH
DOLLAR HE PAID. WHEN PEOPLE REFER TO “THE EXCHANGE RATE’’ BETWEEN TWO COUNTRIES,
THEY USUALLY MEAN THE NOMINAL EXCHANGE RATE.

19. THE REAL EXCHANGE RATE
• THE REAL EXCHANGE RATE TELLS US THE RATE AT WHICH WE CAN TRADE THE GOODS OF ONE
COUNTRY FOR THE GOODS OF ANOTHER.
• THE REAL EXCHANGE RATE IS SOMETIMES CALLED THE TERMS OF TRADE.
• EX: SUPPOSE AN AMERICAN CAR COSTS $10,000 AND A SIMILAR JAPANESE CAR COSTS
2,400,000 YEN. TO COMPARE THE PRICES OF THE TWO CARS, WE MUST CONVERT THEM INTO
A COMMON CURRENCY. IF A DOLLAR IS WORTH 120 YEN, THEN THE AMERICAN CAR COSTS
1,200,000 YEN. COMPARING THE PRICE OF THE AMERICAN CAR (1,200,000 YEN) AND THE
PRICE OF THE JAPANESE CAR (2,400,000 YEN), WE CONCLUDE THAT THE AMERICAN CAR
COSTS ONE-HALF OF WHAT THE JAPANESE CAR COSTS. IN OTHER WORDS, AT CURRENT
PRICES, WE CAN EXCHANGE 2 AMERICAN CARS FOR 1 JAPANESE CAR.