Floating Exchange Rate in India
...atnaik and Peter Pauly (2001) discussed in their report, the movement towards market determined exchange rates in India began with the official devaluation of the Rupee in July 1991. In March 1992 a dual exchange rate system was introduced in the form of the Liberalized Exchange Rate Management System (LERMS). Then, as Renu Kohli (2000) indicated in his article, with the international experience of floating exchange rates, India decided to switch to a floating exchange rate regime in early 1993 after a gradual transition from 1991 to 1993 through a dual exchange rate regime. In fact, the India Rupee is not freely floating exchange rate because RBI actively trades on the market, with the stated goal of ¡°containing volatility¡± and influencing the market price (Ila Patnaik, 2004). Thereby, India is adopting a managed floating exchange rate regime currently. I will give more details and analysis about how India managed exchange rate in its foreign exchange market in next section. The fluctuation of exchange rate of India in the last decade International experience has shown that the vary form a fixed exchange rate regime to a floating exchange rate regime has inevitably been accompanied by a rise in exchange rate volatility. Practically, implied by Renu Kohli (2000), all industrialized countries that changed over to flexible exchange rate regimes after the collapse of the Bretton Woods arrangement witnessed a rise in the variability of their exchange rates. Given the switchover to a flexible exchange rate arrangement in India in 1993, there were observable changes in foreign exchange market in past thirteen years. So I want to deep into the fluctuation of exchange rate of India in the last past ten years form 1997 to 2006. The January averages of Exchange Rate of INR - USD from 1997 to 2006 can be counted by using DATABASE RETRIEVAL SYSTEM (v2.11) of PACIFIC Exchange Rate Service. Indian rupees per US dollar, January Averages are shown as following: 44.209 (01/2006) 45.656 (01/2005) 45.412 (01/2004) 47.901 (01/2003) 48.296 (01/2002) 46.538 (01/2001) 43.536 (01/2000) 42.496 (01/1999) 39.104 (01/1998) 35.810 (01/1997) I begin the analysis by showing a figure to indicate changes of exchange rates in India at every January from 1996 to 2006. It can be obviously seen that the exchange rate has experienced a great changes in past ten years. The value of exchange rate increase form 35.810 in 1997 to the highest point of 48.296 in 2003 and then decrease to the point of 44.209 in 2006. However, what factors drive those fluctuations and what was happened behind those numbers? The answer should be given in next section. Figure A: Yearly Indian Rupees Rate against US Dollar 1997-2006 The factors that resulted in varying exchange rate in India from 1997 to 2006 It is obviously can be seen in the previous figure A, the exchange rate of India Rupee changed form 35.810 in 1997 to the 44.209, the historical highest point, in 2003. Although, and then it decreased lightly to the rate of 44.209 in Jan 2006, the curve of exchange rate of India Rupee are ascending fluctuantly during 1997-2006. There are some reasons why the exchange rate of India Rupee moved like this. Firstly, the movements in the exchange rate during 1997-2006 corrected for the appreciation of Rupee in real effective exchange rate terms, which had occurred over the precious two years. Secondly, the inflation differential between India and its major trading partners also leaded to those movements. More specifically, the rate of inflation in India, which is significantly higher than the inflation rates in India's partner countries, has tended to offset the competitive advantage gained by the nominal depreciation of the rupee. Based on the report form India Government (1999), the effect of the adverse inflation differential was reinforced by the nominal appreciation of the rupee against the Japanese Yen, Deutsche Mark and the French Franc, following the strengthening of the US dollar against these currencies in the international currency markets form 1997 to 1999. Moreover, the market driven correction in the exchange rate offset some of the competitive disadvantages arising form the sharp depreciation of currencies of India¡¯s competitors in East Asia and neighboring countries and helped restrain import growth and strengthen India¡¯s efforts at cost effective import substitution. As a result, the export-weighted real effective exchange rate (REER) of the rupee took into account the exchange rate changes of the rupee. Thirdly, the India government permitted authorized dealers to provide forward cover to foreign institutional investors in respect of their fresh investments in India in equity. The government also allowed authorized deale...