Modified Liberalized Exchange Rate Management System (Modified LERMS)

The process of liberalization continued further and it was decided to make the Rupee fully floating with effect from March 1, 1993. The new arrangement is called Modified Liberalized Exchange Rate Management System or Modified LERMS. Its salient features are as under:

Effective March 1, 1993, all foreign exchange transactions, receipts and payments, both under current and capital accounts of balance of payments are being put through by authorized dealers at market determined exchange rates. Foreign exchange receipts and payments, however, continued to be governed by Exchange Control Regulations. Foreign exchange receipts are to be surrendered to the authorized dealers except in cases where the residents have been permitted by RBI to retain them either with the banks in India or abroad. Authorized dealers are free to retain the entire foreign exchange surrendered to them for being sold for permissible transactions and are not required to surrender to the Reserve Bank any portion of such receipts.

Reserve Bank of India, under Section 40 of RBI Act, 1934, was obliged to buy and sell foreign exchange to the authorized dealers. Reserve Bank is now required to sell any authorized person at its offices/branches US Dollars for meeting foreign exchange payments at its exchange rates based on the market rate only for such purposes as are approved by the Central Government. The RBI buys spot US Dollars from authorized dealers at its exchange rate. Reserve Bank does not ordinarily buy spot Pound Sterling, Deutsche Mark and Japanese Yen. It does not buy forward any currency. The exchange rate at which the RBI buys and sells foreign exchange is in the ± 5% band of the market rate. Also, the RBI announces the reference rate at 12:00 hours which is the rate at which transactions with IMF/IBRD etc. are undertaken.

Advantages of the New System

  • The system seeks to ensure equilibrium between demand and supply with respect to a fairly large subset of external transactions.
  • It has facilitated removal of several trade restrictions and granted relaxation in exchange control (under current account transactions).
  • It is a step towards full convertibility of current account transactions in order to achieve the full benefits of integrating the Indian economy with the world economic system.
  • The incentives to exporters will be higher and more particularly to those whose exports are not highly import intensive. Exporters of agricultural products will find exports attractive.
  • A large number of expatriates, who are hitherto denied any advantages on their remittances to India in line with the earnings of the exporters, are now eligible for market rate for the full amount of remittances being in the nature of capital inflows.
  • This system, coupled with the exchange control relaxation in certain areas, and the abolition of travel tax is expected to make the havala route less tempting. In this context it needs to be remembered that smaller the gap between the average rate received by the exporters and other earners of foreign exchange and the market rate, the lesser will be the temptation to continue using illegal channels for remittances.
  • In the fiscal area, customs revenue is likely to be higher, other things being the same, to the extent the valuation of imports would be based on the market exchange rate. It is, however, necessary to ensure that the tariff rates together with higher input values do not result in a sharp increase in import costs.

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