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REIMAGINING INDIA
Figure 3: Post-reform Exchange Rate Variability
Prior to 1991, the exchange rate regime
in India, was pegged to a currency The plots show the nominal exchange
the currency.
basket. Hence India had a fixed rate rate remained almost stable during the
regime. Figure 1 plots the exchange rate two decades of the 1970’s and 1980’s.
and its annual change, for rupee from The rate of change moved in a band of
1970 to 1990. A positive change +/- 6 percent in the 1970’s except for
indicates depreciation and a negative
change indicates appreciation of percent due to the oil price
1979 when the rupee depreciated by 10
shock.
During the 1991 financial crisis, faced
with very low forex reserves the government
floated the rupee, though the
transition was gradual. Between 1991-
93 there was a dual exchange rate regime
and the rupee was subsequently
floated in early 1993. International experience
has shown exchange rate variability
increases with a change to a
more flexible rate regime. This has not
been the case for India even after a decade
of a floating rate regime as evident
from the Figure 2 which plots the real
effective exchange rate for the rupee
from 1993-2002. This is essentially because
a stable exchange rate remains an
important objective of government exchange
rate policy. Saggar (1999) notes
the RBI’s intervention (measured by
changes in foreign reserves) has in fact
increased in the post 1993 period.
The central bank has used both direct
and indirect methods of market
intervention. 5 The main objective of
government policy is to keep the exchange
rate aligned with the fundamentals
of the economy like inflation. Thus
the exchange rate depreciated by 1.5
percent in September 1997 and the
speed of depreciation was moderated
by intervention sales by the RBI. In the
central banks’ own words “...the conduct
of exchange rate policy was guided
by the need to maintain a delicate balance
between the considerations of external
competitiveness and price stability”
(RBI, 1997, page I-9). This is also
confirmed by analyzing the standard
deviation of the rate of change in exchange
rates, a measure of variability
of the exchange rate. The standard deviation
was 4.7 from 1970-80, 4.6 from
1980-90 and 4.7 from 1993-2003. This
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