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Exchange Rate Management

Exchange rate management in India has evolved since independence. Currently, India follows a managed floating exchange rate system between a free float and a fixed rate. The Reserve Bank of India manages exchange rates through monitoring factors like inflation, interest rates, the balance of payments, and economic performance. A recent crisis in 2013 saw the rupee depreciate sharply against the US dollar due to reversals in capital flows and a high current account deficit. The RBI adopted measures to stabilize the rupee and boost foreign exchange reserves.

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Rohit Jangid
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190 views19 pages

Exchange Rate Management

Exchange rate management in India has evolved since independence. Currently, India follows a managed floating exchange rate system between a free float and a fixed rate. The Reserve Bank of India manages exchange rates through monitoring factors like inflation, interest rates, the balance of payments, and economic performance. A recent crisis in 2013 saw the rupee depreciate sharply against the US dollar due to reversals in capital flows and a high current account deficit. The RBI adopted measures to stabilize the rupee and boost foreign exchange reserves.

Uploaded by

Rohit Jangid
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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EXCHANGE RATE

MANAGEMENT in
INDIA
Group 9:
CHARU | MEHAK | MONICA | ROHIT | SWATI |
VAISHALI | ANIRUDH

INTRODUCTION: Journey since Independence

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INTRODUCTION: Exchange Rate


Exchange Rate: Rate at which currency of one country is exchanged for currency of
another currency
Exchange Rate Quotations:

Direct Quotation: If domestic currency appreciates, exchange rate number decreases

Indirect Quotation: If foreign currency appreciates, exchange rate number increases implying
depreciation of the domestic currency

Exchange Rate Regimes:

Floating Exchange Rate

Pegged Float Exchange Rate

Fixed Exchange Rate

INTRODUCTION: Exchange Rate (contd.)


Factors Affecting Exchange Rate:

Inflation: A country having a lower inflation rate exhibits a rising currency value as there is an
increase its purchasing power in relation to the other currencies

Interest Rate: Higher interest rates offer a higher return relative to other countries, thus,
attracting foreign investment and causing the exchange rates to rise

Balance of Payments: A rise in demand for foreign currency would lower the country's
exchange rate

Public Debt: Considering the debt burden and risk of default, foreigners investments in own
securities denominated in that currency would be lower, causing a fall in the value of the
exchange rate

Economic Performance: Recession causes depreciation in the exchange rate as interest rates
usually fall during recession

IMPOSSIBLE TRINITY

BALANCE of PAYMENTS
Summarizes the economic transactions
of an economy with the rest of the world
for a specific period
RBI responsible for compilation &
dissemination of BoP data in India

BoP must always balance i.e.


CA + KA + RFX = 0
BoP surplus (i.e. >0) Creates foreign
exchange reserves (strength of
economy)
BoP deficit (i.e. < 0) Depletes foreign
exchange reserves (sign of weakness)

BoP Components
Current Account(Exports Imports)
Merchandise
Invisibles

Capital Account(Capital Inflow Capital Outflow)


FDI
Portfolio Investment
Other investments

Reserves
Purchase/Sale of official reserve

Net errors & Omissions

BALANCE of PAYMENTS- INDIA SCENARIO


Past Scenario:

From 2006-07 to 2007-08, BoP increased


(surplus), exchange rate reduced from INR
45.28=$1 to 40.241 = $1. This was due to falling
demand for $, led to appreciation of Rupee.
From 2007-08 to 2008-09, BoP decreased
(deficit), exchange rate increased from INR
40.241=$1 to INR 45.91 = $1. This was due to
increasing demand for $, led to depreciation of
Rupee

Overall Balance of Payments

Capital Account

Current Account

150000

100000

50000

Current Scenario:

According to Economic survey 2014, Indias BoP


remained surplus for 4th consecutive year at $6.9
billion (Q2)
This was $11.2 billion narrower than surplus in
Q1
In September 2014, CAD increased to 2.1% of GDP
from 1.7% of GDP in first quarter of current
financial year
This was due to slow growth of exports & imports
increased due to increasing demand for gold

0
45.2849

40.241

45.917

47.41

45.57

47.922

-50000

-100000

EXCHANGE RATE

2006-07 to 2013-14

54.4091 60.5019

THE MARSHALL LERNER CONDITION

J CURVE and EXCHANGE RATE


J-curve depicts the shape which the trend of a countrys trade balance follows owing to
depreciation or devaluation
A lower exchange rate implies cheaper exports and expensive imports, that make the
current account worse
The volume of exports starts increasing over time given lower prices to foreign buyers,
the domestic consumers will buy fewer of the costlier imports
Eventually, the trade balance starts improving from what it was before the devaluation
forming a J shaped curve

In cases of appreciation of currency, there might be an inverted J-curve.

J CURVE and EXCHANGE RATE:


Rupee Devaluation in 1991
BoP problems began in 1985 - exports
continued to grow; interest payments and
imports rose faster ensuring consistent
current account deficits
India followed a fixed exchange rate system

Gulf War led to higher imports owing to an


increase in oil prices
1990:
Trade Deficit US $ 9.44 billion
Current Account Deficit US $ 9.7 billion
Govt. established dual exchange rate regime:
Payment for some imports at free-market
rates and others imports at a governmentmandated rate

J CURVE and EXCHANGE RATE:


Rupee Devaluation in 2012

1993 onwards, India followed a flexible exchange


rate system

Depreciation of Indian rupee in 2012 (more than


12%) compressed trade deficit and CAD by making
imports expensive

Monthly Trade Deficit, 2012:


beginning $19 billion
May 2012 $15 billion
June 2012 $11 billion

Gold imports decreased, non-oil and non-gold deficit


improved dramatically

Compression of trade deficit on account of real


depreciation of currency defined the J-curve for
India

EXCHANGE RATE in the LONG RUN


In the long run, exchange rate is determined by the productivity and inflation under
flexible exchange rate system

Effect of
Productivity

Increase in
Productivity
Decrease in Cost
of Production

Effect of
Inflation

Increase in
Inflation
Increase in Cost
of Production

Cheaper Goods

Costlier Goods

Increased Demand
Increased Exports

Decreased
Exports

Appreciation of
Currency

Depreciation of
Currency

THEORY of PURCHASING POWER PARITY (PPP)


The exchange rate at which, when we convert domestic currency into foreign currency,
we can purchase same quantity of goods at home or abroad.

R = ePf
P

e: Exchange Rate
Pf : Price in Dollars
P: Price in Rupees

R=1

e = PPP Exchange Rate

R>1

Increased demand for domestically produced goods


This will drive up prices at home and drive down prices abroad

R<1

Increased demand for foreign produced goods.


This will drive up prices abroad and drive down prices at home

In the long
run Real
Exchange
Rate reaches
1, i.e. moves
closer to PPP

EXCHANGE RATE MANAGEMENT in INDIA


Current Scenario
Managed exchange rate system which is a system between a free floating one and a fully
managed one

International Method:

Indian Method

R = ePf / P

REER= NEER*(Pi/Pf)

REER: Real Effective Exchange Rate


NEER: Normal Effective Exchange Rate. It is an indirect quote i.e. x dollars = Re.1

Indices of Real Effective Exchange Rate (REER) and Nominal Effective Exchange Rate (NEER) of the Indian Rupee
6 currency base year 2004

Year/
Month

REER

Appreciation (+) / Depreciation (-) in


REER over previous month (%)

NEER

Appreciation (+) / Depreciation (-) in


NEER over previous month (%)

2012-13 (Provisional)
April
107.1
May
103.6
June
101.6
July
103.7
August
104.1
September
105.2
October
107.2
November
104.6
December
104.3
January
105.2
February
106.5
March
106.5
2013-14 (Provisional)
April
106.7
May
105.6
June
98.8

-3.27
-1.93
2.07
0.39
1.06
1.90
-2.43
-0.29
0.86
1.24
0.00

78.7
75.5
74
75.2
74.8
75
76.9
74.7
74.6
75
76
76

-4.07
-1.99
1.62
-0.53
0.27
2.53
-2.86
-0.13
0.54
1.33
0.00

-1.03
-6.44

76
75.2
70.5

-1.05
-6.25

*Source: Annual Report (22/08/2013), Reserve Bank of India

Downward movement in index shows currency depreciation while upward movement in index
reflects currency appreciation.

THE RECENT CRISIS


Movement of Exchange Rate post May, 2013

Rupee depreciated sharply by around


19.4% against the US dollar between
May 22, 2013 and August 28, 2013

Reasons:
sharp reversals in capital inflows
unsustainable levels of CAD (4.8%)

sharp deceleration in GDP growth


rate
high inflation (7.4%)
large fiscal deficit (4.9%)
*Source: Annual Report (22/08/2013), Reserve Bank of India

MEASURES ADOPTED
In August 2013, the Reserve Bank under Governor Subbarao, in a bid to shore up the rupee, tried to reduce
the demand by decreasing overseas investment limit by Indian Companies to 100% of their net worth from
400% and cutting oversees remittances by Indians to $75,000 a year from $200,000
But, foreign investors did not like these controls and they started withdrawing their money from the country
Governor Raghuram Rajan focused on reducing investors fears. So, he rolled back the investment limit and
increased overseas remittances

OTHER MEASURES:
Banks allowed to raise 100% of unimpaired Tier 1 capital through overseas borrowings
MNCs permitted to enhance stake in companies within the stipulated FDI norms without its permission
A special window provided for banks to swap foreign currency non-resident (FCNR) dollar deposits at a fixed
rate of 3.5% p.a.
Trade with other emerging economies allowed to be conducted in local currency and not in dollars

CONCLUSION
The Indian economy is still vulnerable to external economic environment - fear of
tapering of US Feds bond purchase and flight of capital through the FIIs route caused
serious depreciation of rupee and depletion of foreign exchange reserves
This calls for new instruments to build up foreign exchange reserves and strengthen
rupee on long term basis such as

swap arrangement for NRI deposits with banks

measures to control gold import

rupee payment system with countries exporting oil to India

Though monetary policies have a significant role to play in the management


of volatility of capital inflows and foreign exchange reserves, the long term stability for
the economy calls for fiscal policies

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