Exchange Rate and Librelisation

Liberalisation And
Exchange Rate
Regimes In India
Liberalisation refers to a relaxation of
previous government restrictions, usually in
such areas of social and economic policy.
Deregulation.
Liberalisation
It is the value of a foreign nation‟s currency in
terms of the home nation‟s currency.
By April 2013, daily turnover was reported to
be over US $ 5.3 trillion.
Foreign-exchange rate, Forex rate or FX rate.
Exchange Rate
Source: www.rbi.org

Par value system
Permitted margin of ±1 per cent
Pound sterling as the intervention currency
Exchange markets were practically de-
functional
In 1949 & 1966 the rupee was devaluated to
2.88 & 1.83 grains of fine gold respectively.
Bretton Wood system fails
In 70s, banks in India became interested in
trading in foreign exchange.

1947-1977
Early stage
To regulate dealings in foreign exchange and
securities
To regulate the transaction indirectly affecting
foreign exchange
To regulate import and export of currency and
bullion
To regulate employment of foreign nationals
To regulate foreign companies
To regulate acquisition, holding etc. of
immovable property in India by non-residents


1973 - FERA
Banks were allowed Intraday trading in
foreign exchange
Limits as well as the uncovered position
overnight decided by the management of
banks.
Officially determined daily by RBI
Authorised dealers (AD)
Highly regulated FERA
“The Hawala”





1978-1992
Formative stage
Exchange rate was highly over-valued.
Strict exchange controls applied to not just
capital account but also current account
transactions
Foreign investment was subject to stringent
restrictions
Foreign investment amounted to a paltry
$100-200 million annually


Before Liberalisation
Indian economy underwent a severe balance-
of-payments crisis
By the summer of 1991, India's foreign
exchange reserves covered less than two
weeks of imports.
High rate of inflation
Fleeing non-resident deposits
Declining production and a serious likelihood
of an unprecedented external payments
default by India.

1991
The 1991 Balance of Payments crisis
forced India to procure a $1.8 billion I.M.F
loan.
From Bank of England and Bank of France
and raised a short-term loan of $405 million
The economic reforms were thus introduced
because of the I.M.F conditionality and not
because of any sudden change of economic
philosophy by the Government.


Liberalisation
RBI's announced depreciation of the rupee,
in two instalments on July 1 and 3, 1991.
The value of the rupee declined by 18-19 %
against major currencies to improve the
competitiveness of Indian exports.
In march 1992 the LERMS (Liberalized
Exchange Rate Management System)
involving dual exchange rate was introduced
In March 1, 1993, leading to the introduction
of a market-determined exchange rate
regime
Sodhani Committee (1994)




Post LPG
1
st
June 2000, FERA was repealed to FEMA
(Foreign exchange management act.)
FERA had a controversial 27 year stint during
which Indian Corporate world found
themselves at the mercy of the
Enforcement Directorate.
Offense under FERA was a criminal offence
liable to imprisonment, whereas FEMA seeks
to make offenses relating to foreign exchange
civil offences.
Money laundering and the hawala (unofficial)
market.

FERA to FEMA
Capital Account Convertibility (CAC) means
the freedom to convert local financial assets
into foreign financial assets and vice versa at
market determined rates of exchange
It refers to the removal of restraints on
international flows on a country's capital
account, enabling full convertibility and
opening of the financial system

CAC
Why do some countries choose to fix
and others to float?
Why do they change their minds at different
times?
These are among the most enduring and
controversial questions in international
macroeconomics.
Pros and cons

Fix or Floating
Stabilizes the value of a currency
Makes trade and investments between the
two countries easier and predictable
Means to control inflation
Helps keep businesses competitive in foreign
markets


Fix: Pros
Heavy burden on exchange reserve
Country must have sufficient reserve
Fails to solve the balance of payment
disequilibrium
It is not a long term solution if the underlying
economy is weak.
International disagreement might be created
when a country sets its exchange rate on a
too low level
Fixing the exchange rate is not easy


Fix: Cons
Simple operation, smoother, more fluid
adjustment
Brings realism in forex transactions
Disequilibrium in balance of payment is auto
stabilized
No need to maintain large forex reserve


Floating: Pros
Tends to create uncertainty on the
international markets.
Encourages inflation
Floating exchange rates are affected by more
factors than only demand and supply, such
as government intervention
Adverse effect of speculation
Floating: Cons
Source: www.economicshelp.org
Devaluation
– the price of foreign currencies under a fixed
exchange rate regime is increased by official
action

Revaluation
- the price of foreign currencies under a fixed
exchange rate regime is decreased by official
action

Depreciation
– under a floating rate system, price of foreign
currencies increases because of market
adjustment

Appreciation
- under a floating rate system, price of foreign
currencies decreases because of market
adjustment

Terms to know
In 1991, India pawned 67 tons of gold to tide
over a balance of payments crisis.
18 years later, the Reserve Bank of India has
bought thrice that amount of gold from the
I.M.F to diversify its assets

Then and now…..
Year The Foreign Exchange Market and Exchange Rate
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.
1971 Breakdown of the Bretton-Woods system and floatation of major currencies. Rupee was linked to
the pound sterling in December 1971.
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.
1978 RBI allowed the domestic banks to undertake intra-day trading in foreign exchange.
1978-1992 Banks began to start quoting two-way prices against the Rupee as well as in other currencies.
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).
These restrictions resulted in an extremely efficient unofficial parallel (hawala) market for foreign
exchange.
1990-1991 Balance of Payments crisis
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.
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.
March 1993 The dual rates converged, and the market determined exchange rate regime was introduced. All
foreign exchange receipts could now be converted at market determined exchange rates.
Source: www.rbi.org
Can the Dollar remain king or not, is no
longer a million dollar question, but a million
Rupee question!
Thank you