History of Exchange Rate Mechanism in India

India was a founder member of the International Monetary Fund (IMF). It followed the fixed parity system till the early 1970s as a result which the value of the rupee in terms of gold was originally fixed as the equivalent of 0.268601 gram of fine gold. In view of India’s long economic and political relations with England and membership of the sterling area from September 1939 to June 1972, the rupee was pegged to the pound sterling. The exchange rate was thus remained unchanged but the gold content of the rupee fell to 0.186621 gram. Again, with the devaluation of the Indian rupee in June 1996 the gold content fell further to 0.118489 gram. The following year, the pound was also devalued. This devaluation did have an impact on the rupee pound link, but the rupee was kept stable in terms of the pound. The latter continued as an intervention currency.

In August 1971 when the system of fixed parity was under a cloud, the rupee was briefly pegged to the US dollar at Rs. 7.50/US $ and this continued till December 1971. The peg to the dollar was not very effective as the pound sterling remained to continue as the intervention currency. In December 1971, the rupee returned to the sterling peg at a parity of Rs. 18.9677/£ with of  course , a margin of ±2.2 percent.

After the Smithsonian arrangement had failed  and the pound had began to float, the rupee tended to depreciate. The Reserve Bank of India  then had to delink it from the pound sterling in September 1975 and link it with a basket of five currencies; but the pound sterling was retained as the intervention currency for fixing the external value of the rupee. The weight of different currencies forming the basket remained confidential and the exchange rate  continued  to be administered. The administered rate did not keep pace with the growing rate of inflation and this resulted in a widening gap between the real and the nominal exchange rates that was more evident during  the late 1980s and early 1990s. Thus, when economic reforms were initiated in the  country, the rupee was depreciated by around 20 percent in two successive installments in the first weeks of July 1991. In absolute terms, depreciation occurred from Rs. 21.201/US $ to Rs. 25.80 /US $

From March 1992 a dual exchange rate system was introduced, in terms of which 40 percent of export earnings were to be converted at the official exchange rate prescribed by the Reserve Bank of India and the remaining 60 percent were to be converted at market determined rates. The US dollar  was the intervention  currency. From March 1993 the receipts on merchandise trade account and some of the items of invisible trade account came to be convertible entirely at the market determined rates on all items of current account.

The adoption of the unified  exchange rate system form March 1993 means adoption of a floating-rate regime, but it is a managed floating and the reserve Bank of India intervenes in the foreign exchange market in order to influence the value of the rupee. In the first two years, the value of the rupee remained stable but the onward, it has been depreciating despite RBI’s intervention.

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