EXCHANGE RATE - ECONOMY
News: IMF
reclassifies India’s exchange rate regime to ‘stabilized arrangement’ from
‘floating’
What's in the news?
● The
International Monetary Fund has reclassified India's "de facto"
exchange rate regime to "stabilized arrangement" from
"floating" for December 2022 to October 2023, the first such instance
of such reclassification following an article IV review of the country's
policies.
Key takeaways:
● According
to the IMF's staff assessment, forex intervention by the Reserve Bank of India
likely exceeded levels necessary to address disorderly market conditions and
has contributed to the rupee-dollar moving within a narrow range since December
2022.
Exchange Rate:
● Exchange
Rate is defined as the rate at which a country’s currency can be exchanged with
another country’s currency.
● In
other words, it is the value of one country’s currency with respect to another
country’s currency.
Types of Exchange Rates:
1. Fixed Exchange Rate:
● In
this system, government or central
bank ties the country’s currency official exchange rate to another
country’s currency (currency peg) or the price of gold (gold standard).
● Fixed
rates provide greater certainty for exporters and importers and also help the
government maintain low inflation.
● The
purpose of a fixed exchange rate system is to keep a currency’s value within a
narrow band.
2. Floating/Flexible Exchange Rate:
● Such
exchange rates are also called market-driven
or based exchange rates, which are regulated by factors such as the demand
and supply of the domestic and the foreign currencies in the concerned economy.
● In
the floating exchange rate system, a domestic
currency is left free to float against a number of foreign currencies in its
foreign exchange market and determine its own value.
● Failure
of the gold standard and the Bretton Woods Agreement led to
increased popularity of this system.
3. Managed Exchange Rate:
● A
managed-exchange-rate system is a hybrid
or mixture of the fixed and flexible exchange rate systems in which the
government of the economy attempts to affect the exchange rate directly by
buying or selling foreign currencies or indirectly, through monetary policy (by
lowering/raising interest rates on foreign currency bank accounts, etc.)
Exchange Rate in India:
● Indian
currency, the ‘rupee’, was historically linked with the British Pound Sterling
till 1948 which was fixed as far
back as 1928.
● Once
the IMF came up, India shifted to the fixed currency system committed to
maintaining the rupee's external value (i.e., exchange rate) in terms of gold
or the US ( Dollar).
● In
September 1975, India delinked rupee
from the British Pound and the RBI started determining rupee’s exchange rate
with respect to the exchange rate movements of the basket of world currencies. This
was an arrangement between the fixed and
the floating currency regimes.
● India
announced the Liberalized Exchange Rate
Mechanism System (LERMS) in the Union Budget 1992–93 and in March 1993
it was operationalized. India delinked its currency from the fixed currency
system and moved into the era of floating exchange rate system under it.
● The
Indian form of the exchange rate is known as the ‘dual exchange rate’, one exchange rate of rupee is official and
the other is market-driven. The market driven exchange rate shows the actual
tendencies of the foreign currency demand and supply in the economy vis-á-vis
the domestic currency.
● It
is the market-driven exchange rate which affects the official rate and not the
other way round.