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INTRODUCTION History of Rupee India was one of the first issuers of coins (circa: 6th Century BC), and as a result it has seen a wide range of monetary units throughout its history. There is some historical evidence to show that the first coins may have been introduced somewhere between 2500 and 1750 BC. However, the first documented coins date from between the 7th/6th century BC to the 1st century AD. These coins are called 'Punch-marked' coins because of their manufacturing technique.

Over the next few centuries, as traditions developed and empires rose and fell, the country's coinage designs reflected its progression and often depicted dynasties, sociopolitical events, deities, and nature. This included dynastic coins, representing Greek Gods of the Indo-Greek period followed by the Western Kshatrapa copper coins from between the 1st and the 4th Century AD.

In 712 AD, the Arabs conquered the Indian province of Sindh and brought their influence and coverage with them. By the 12th Century, Turkish Sultans of Delhi replaced the longstanding Arab designs and replaced them with Islamic calligraphy. This currency was referred to as 'Tanka' and the lower valued coins, 'Jittals'. The Delhi Sultanate attempted to standardise this monetary system and coins were subsequently made in gold, silver and copper. In 1526, the Mughal period commenced, bringing forth a unified and consolidated monetary system for the entire Empire.

The first "Rupee" is believed to have been introduced by Sher Shah Suri (1486–1545), based on a ratio of 40 copper pieces (paisa) per rupee. Among the earliest issues of paper rupees were those by the Bank of Hindustan (1770–1832), the General Bank of Bengal and Bihar (1773–75, established by Warren Hastings) and the Bengal Bank (1784–91), amongst others. Until 1815, the Madras Presidency also issued a currency based on the Panam, with 12 panams equal to the rupee.


Historically, the rupee, derived from the Sanskrit word raupya, which means Silver, was a silver coin. This had severe consequences in the nineteenth century, when the strongest economies in the world were on the gold standard. The discovery of vast quantities of silver in the U.S. and various European colonies resulted in a decline in the relative value of silver to gold. Suddenly the standard currency of India could not buy as much from the outside world. This event was known as "the fall of the rupee". India was not affected by the imperial order-in-council of 1825 that attempted to introduce the British sterling coinage to the British colonies. British India at that time was controlled by the British East India Company. The silver rupee continued as the currency of India throughout the entire period of the British Raj and beyond. In 1835, British India set itself firmly upon a mono-metallic silver standard based on the rupee. His decision was influenced by a letter, written in the year 1805, by Lord Liverpool that extolled the virtues of monometallism.

Following the Indian Mutiny in 1857, the British government took direct control of British India. Since 1851, gold sovereigns were being produced in large numbers at the Royal Mint branch in Sydney, New South Wales. In the year 1864 in an attempt to make the British gold sovereign become the 'imperial coin', the treasuries in Bombay and Calcutta were instructed


to receive gold sovereigns. These gold sovereigns however never left the vaults. As was realized in the previous decade in Canada and the next year in Hong Kong, existing habits are hard to replace. Just as the British government had finally given up any hopes of replacing the rupee in India with the pound sterling, it simultaneously realized, and for the same reasons, that they could not easily replace the silver dollar in the Straits Settlements with the Indian rupee, as had been the desire of the British East India Company. Since the great silver crisis of 1873, a growing number of nations had been adopting the gold standard, however the Indian currency system maintained its silver-standard tradition, which remained until it was replaced by a basket of commodities and currencies in the late twentieth century. The Indian rupee replaced the Danish Indian rupee in 1845, the French Indian rupee in 1954 and the Portuguese Indian escudo in 1961. Following independence in 1947, the Indian rupee replaced all the currencies of the previously autonomous states. Some of these states had issued rupees equal to those issued by the British (such as the Travancore rupee). Other currencies included the Hyderabad rupee and the Kutch kori. Nominal value during British rule, and the first decade of independence: 

1 damidi (pie) = 0.520833 paise (1/12 Anna)

1 kani (pice) = 1.5625 paise (1/4 Anna)

1 paraka = 3.125 paise (1/2 Anna)

1 anna = 6.25 paise (1 Anna)

1 beda = 12.5 paise (2 Anna)

1 pavala = 25 paise (4 Anna)

1 artharupee = 50 paise (8 Anna)

1 rupee = 100 paise (16 Anna)

In 1957, decimalization occurred and the rupee was divided into 100 nayepaise (Hindi for "new paise"). In 1964, the initial "naye" was dropped. Many still refer to 25, 50 and 75 paise as 4, 8 and 12 annas respectively, not unlike the usage of "bit" in American English for ⅛ dollar.


The One Rupee Banknote, now not in use.

The two-rupee banknote

French Indian 1 rupee (1938)

One rupee —Obverse

The rupee on the East African coast and South Arabia In East Africa, Arabia, and Mesopotamia the Rupee and its subsidiary coinage was current at various times. The usage of the Rupee in East Africa extended from Somalia in the north, to as far south as Natal. In Mozambique the British India rupees were overstamped, and in Kenya the British East Africa Company minted the rupee and its fractions as well as pice. The rise in the price of silver immediately after the First World War caused the rupee to rise in value to two shillings sterling. In 1920 in British East Africa, the opportunity was then taken to introduce a new florin coin, hence bringing the currency into line with sterling. Shortly after that, the Florin was split into two East African shillings. This assimilation to sterling did not however happen in British India itself. In Somalia the Italian colonial authority minted 'rupia' to exactly the same standard, and called the pice 'besa'. The rupee in the Straits Settlements The Straits Settlements were originally an outlier of the British East India Company. The Spanish dollar had already taken hold in the Straits Settlements by the time the British arrived in the nineteenth century, however, the East India Company tried to introduce the rupee in its place. These attempts were resisted by the locals, and by 1867 when the British


government took over direct control of the Straits Settlements from the East India Company, attempts to introduce the rupee were finally abandoned. International use With Partition, the Pakistani rupee came into existence, initially using Indian coins and Indian currency notes simply overstamped with "Pakistan". In previous times, the Indian rupee was an official currency of other countries, including Aden, Oman, Kuwait, Bahrain, Qatar, the Trucial States, Kenya, Tanganyika, Uganda, the Seychelles, and Mauritius. The Indian government introduced the Gulf rupee, also known as the Persian Gulf rupee (XPGR), as a replacement for the Indian rupee for circulation exclusively outside the country with the Reserve Bank of India [Amendment] Act, 1 May 1959. This creation of a separate currency was an attempt to reduce the strain put on India's foreign reserves by gold smuggling. After India devalued the rupee on 6 June 1966, those countries still using it – Oman, Qatar, and the Trucial States (which became the United Arab Emirates in 1971) – replaced the Gulf rupee with their own currencies. Kuwait and Bahrain had already done so in 1961 and 1965 respectively.The Bhutanese ngultrum is pegged at par with the Indian rupee, and both currencies are accepted in Bhutan. The Indian rupee is also accepted in towns in Nepal which lie near the border with India. However, Indian Rupee denominations of 500 and 1000 are banned in Nepal.Rupee is the currency of Sri Lanka also.





SECURITY FEATURES IN THE NOTES *Watermark — White side panel of notes has Mahatma Gandhi watermark.

*Security thread — All notes have a silver security band with inscriptions visible when held against light.

*Latent image — Higher denominational notes display note's denominational value in numerals when held horizontally at eye level.

*Microlettering — Numeral denominational value is visible under magnifying glass between security thread and watermark.

*Fluorescence — Number panels glow under ultra-violet light.

*Optically variable ink — Notes of Rs. 500 and Rs. 1000 have their numerals printed in optically variable ink. Number appears green when note is held flat but changes to blue when viewed at angle.

*Back-to-back registration — Floral design printed on front and back of note coincides when viewed against light.


Devaluations What Is Devaluation Of Money? Devaluation means officially lowering the value of currency in terms of foreign currencies. There is a difference between devaluation and exchange depreciation. Devaluation is the result of official government action. Depreciation or decline in the rate of exchange of one currency in terms of another is due to market forces. Substantially devaluation and depreciation both refer to the reduction of international currency in terms of foreign currencies. When the rupee was delinked from the dollar and floated against a basket of currencies on Jan 8, 1982, the rupee parity stood rupees 9.90 to a dollar. The State Bank of Pakistan since then has devalued the rupee a number of times. The rupee spot buying rate to dollar








There could be many motives of the devaluation. It stimulates exports of commodities. It restricts import demand for goods and services. It helps in creating a favourable balance of payments. Almost all the countries of the world have devalued their currencies at one time or the other with a view to achieving certain economic objectives. During the great depression of 1930 devaluation was carried by most countries of the world for the objecting of correcting over-valuation of currencies.

The fall of the Rupee Price of silver – Rate of exchange: 1871–72 to 1892–93


Price of silver (inpence per Troy ounce)

Rupee exchange rate (in pence)

1871–1872 60½

23 ⅛

1875–1876 56¾


1879–1880 51¼


1883–1884 50½



1891–1892 45


1892–1893 39


After its victory in the Franco-Prussian War (1870–71), Germany extracted a huge indemnity from France of £200,000,000, and then moved to join Britain on a gold standard for currency. France, the U.S. and other industrializing countries followed Germany in adopting a gold standard throughout the 1870s. At the same time, other countries, such as Japan, which did not have the necessary access to gold or those, such as India, which were subject to imperial policies that determined that they did not move to a gold standard, remained mostly on a silver standard. A huge divide between silver-based and gold-based economies resulted. The worst affected were economies with silver standard that traded mainly with economies with gold standard. With discovery of more and more silver reserves, those currencies based on gold continued to rise in value and those based on silver were declining due to demonetization of silver. For India which carried out most of its trade with gold based countries, especially Britain, the impact of this shift was profound. As the price of silver continued to fall, so too did the exchange value of the rupee, when measured against pound sterling. Since its Independence in 1947, India has faced two major financial crises and two consequent devaluations of the rupee: In 1966 and 1991. 1966 Economic crisis Since 1950, India ran continued trade deficits that increased in magnitude in the 1960s. Furthermore, the Government of India had a budget deficit problem and could not borrow money from abroad or from the private corporate sector, due to that sector’s negative savings rate. As a result, the government issued bonds to the RBI, which increased the money supply, leading to inflation. In 1966, foreign aid, which was hitherto a key factor in preventing devaluation of the rupee was finally cut off and India was told it had to liberalize its restrictions on trade before foreign aid would again materialize. The response was the politically unpopular step of devaluation accompanied by liberalization. Furthermore, The Indo-Pakistani War of 1965 led the US and other countries friendly towards Pakistan to withdraw foreign aid to India, which further necessitated devaluation. Defence spending in 1965/1966 was 24.06% of total expenditure, the highest it has been in the period from 1965 to 1989 (Foundations, pp 195). The second factor is the drought of 1965/1966. The sharp rise in prices in this period, which led to devaluation, was often blamed on the drought by government.


At the end of 1969, the Indian Rupee was trading at around 13 British Pence. A decade later, by 1979, it was trading at around 6 British Pence. Finally by the end of 1989, the Indian Rupee had plunged to an all-time low of 3 British Pence. This triggered the onset of a wave of irreversible liberalization reforms away from populist measures. 1991 Economic crisis 1991 is often cited as the year of economic reform in India. Surely, the government’s economic policies changed drastically in that year, but the 1991 liberalization was an extension of earlier, albeit slower, reform efforts that had begun in the 1970s when India relaxed restrictions on imported capital goods as part of its industrialization plan. Then the ImportExport Policy of 1985-1988 replaced import quotas with tariffs. This represented a major overhaul of Indian trade policy as previously, India’s trade barriers mostly took the form of quantitative restrictions. After 1991, the Government of India further reduced trade barriers by lowering tariffs on imports. In the post-liberalization era, quantitative restrictions have not been significant.

While the devaluation of 1991 was economically necessary to avert a financial crisis, the radical changes in India’s economic policies were, to some extent, undertaken voluntarily by the government of P V Narasimha Rao. As in 1966, there was foreign pressure on India to reform its economy, but in 1991, the government committed itself to liberalization and followed through on that commitment. In 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners.

IMPACT OF DEVALUATION OF RUPEE ON IMPORT AND EXPORT While depreciation is considered to help exports and make imports costlier, imports and exports are affected by a number of factors like growth in world trade, growth in demand for our exports, domestic need for imports, government policies etc. However, depreciation has to be viewed in relation to issues like depreciation by competitors, extent of overvaluation of domestic currency, impact on international debt and foreign investment, extent of domestic inflation etc. In India, exports have performed well during 2000-01 with a growth of 19.83% as against an export target of 18%. Export promotion being a constant endeavor of the government, a number of steps have been taken to enhance the export growth which include


reduction in transaction cost through decentralization, simplification of procedures and various other measures as enumerated in the Exim Policy. Steps have also been taken to promote exports through multilateral and bilateral initiatives, identification of thrust sectors and focus regions. Special Economic Zones are being set up to further boost the exports. Why Indira Gandhi devalued Indian Rupees by 40% in accordance to US Dollars at the time of emergency in 1975? Since 1950, India ran continued trade deficits that increased in magnitude in the 1960s. Furthermore, the Government of India had a budget deficit problem and could not borrow money from abroad or from the private corporate sector, due to that sector’s negative savings rate. As a result, the government issued bonds to the RBI, which increased the money supply, leading to inflation. In 1966, foreign aid, which was hitherto a key factor in preventing devaluation of the rupee was finally cut off and India was told it had to liberalize its restrictions on trade before foreign aid would again materialize.

The response was the politically unpopular step of devaluation accompanied by liberalization. Furthermore, The Indo-Pakistani War of 1965 led the US and other countries friendly towards Pakistan to withdraw foreign aid to India, which further necessitated devaluation. Defence spending in 1965/1966 was 24.06% of total expenditure, the highest it has been in the period from 1965 to 1989 (Foundations, pp 195). The second factor is the drought of 1965/1966. The sharp rise in prices in this period, which led to devaluation, was often blamed on the drought by government.

At the end of 1969, the Indian Rupee was trading at around 13 British Pence. A decade later, by 1979, it was trading at around 6 British Pence. Finally by the end of 1989, the Indian Rupee had plunged to an all-time low of 3 British Pence. This triggered the onset of a wave of irreversible liberalization reforms away from populist measures

Revaluation In the period 2000–2007, the Rupee stopped declining and stabilized ranging between 1 USD = INR 44–48. In recent times, the Indian Rupee had begun to gain value and by 2007 traded around 39 Rs to 1 US dollar , on sustained foreign investment flows into the country. This posed problems for major exporters and BPO firms located in the country. The trend has reversed lately with the 2008 world financial crisis. The changes in the relative value of the


rupee has reflected that of most currencies, e.g. the British Pound, which had gained value against the dollar and then has lost value again with the recession of 2008.

Valuation history

What Went Wrong ?

Clearly, there are many similarities between the devaluation of 1966 and 1991. Both were preceded by large fiscal and current account deficits and by dwindling international confidence in India’s economy. Inflation caused by expansionary monetary and fiscal policy depressed exports and led to consistent trade deficits. In each case, there was a large adverse shock to the economy that precipitated, but did not directly cause, the financial crisis. Additionally, from Independence until State, Market & Economy Centre for Civil Society 89 1991, the policy of the Indian government was to follow the Soviet model of foreign trade by viewing exports as a necessary evil whose sole purpose was to earn foreign currency with which to purchase goods from abroad that could not be produced at home.

As a result, there were inadequate incentives to export and the Indian economy missed out on the gains from comparative advantage. 1991 represented a fundamental paradigm shift in Indian economic policy and the government moved toward a freer trade stance.


It is easy in retrospect to fault the government’s policies for leading to these two major financial crises, but it is more difficult to convincingly state what the government should have done differently that would have averted the crises. One relatively non-controversial target for criticism is the tendency of the Indian government since Independence towards large budget deficits. Basic macroeconomic theory tells us that the current account deficit is roughly equal to the sum of government and private borrowing. Given the fact that the household saving rate in India is quite high, most of the blame for India’s balance of payments problems must rest with the government for its inability to control its own spending.

By borrowing from the Reserve Bank of India and, therefore, essentially printing money, the government could finance its extravagant spending through an inflation tax. Additionally, the large amounts of foreign aid that flowed into India clearly did not encourage fiscal or economic responsibility on the part of the government. In 1966, the lack of foreign aid to India from developed countries could not persuade India to liberalize and in fact further encouraged economic isolation. In 1991, on the other hand, there was a political will on the part of the government to pursue economic liberalization independent of the threats of aid reduction. These two financial episodes in India’s modern history show that engaging in inflationary economic policies in conjunction with a fixed exchange rate regime is a destructive policy. If India had followed a floating exchange rate system instead, the rupee would have been automatically devalued by the market and India would not have faced such financial crises. A fixed exchange rate system can only be viable in the long run when there is no significant long-run inflation.


Exchange rate (rupees per US$)


















2007 (Oct)


2008 (June)


2008 (October)


2009 (October)


2010 22)



2011 (April)



Chronology of India’s exchange rate policies • 1947 (When India became member of IMF): Rupee tied to pound, Re 1 = 1 s, 6 d, rate of 28 October, 1945 • 18 September, 1949: Pound devalued; India maintained par with pound • 6 June, 1966: Rupee is devalued, Rs 4.76 = $1, after devaluation, Rs 7.50 = $1 (57.5%) • 18 November, 1967: UK devalued pound, India did not devalue • August 1971: Rupee pegged to gold/dollar, international financial crisis • 18 December, 1971: Dollar is devalued • 20 December, 1971: Rupee is pegged to pound sterling again • 1971-1979: The Rupee is overvalued due to India’s policy of import substitution • 23 June, 1972: UK floats pound, India maintains fixed exchange rate with pound • 1975: India links rupee with basket of currencies of major trading partners. Although the basket is periodically altered, the link is maintained until the 1991 devaluation. • July 1991: Rupee devalued by 18-19 % • March 1992: Dual exchange rate, LERMS, Liberalized Exchange Rate Management System • March 1993: Unified exchange rate: $1 = Rs 31.37 • 1993/1994: Rupee is made freely convertible for trading, but not for investment purposes


Currency Intervention and its Consequences RBI faces three paths for implementation of India’s de facto peg to the USD: • Direct intervention on the currency market, • Intervention on the currency market at the behest of RBI through other banks such as SBI,1 • Indirect instruments: money supply, interest rates, administrative controls.

It is sometimes argued that currency management can be done in isolation, without affecting other aspects of the macro-economy. It is felt that RBI can modify the market price of the rupee by purchasing or selling USD, which would increase or decrease the size of foreign currency reserves, without incurring any other costs. Such a position was well justified prior to 1992, given the level of repression on current account and capital account transactions that prevailed in India, backed by FERA. However, there is a considerable clarity in the field of open economy macroeconomics, on the downstream ramifications of currency intervention, which suggests that the implementation of currency policy in an open economy does have important costs, and consequences for macro-policy.

There are broadly two parallel strands of thought on this question: • The first explores the monetary impact of currency intervention, where policy makers are faced with the choice of distorted money supply (and its consequences) or sterilization (and its consequences). When sterilization takes place, it has fiscal costs. • The second strand of thought focuses on the direct fiscal costs of coping with successful speculative behavior by private actors. With increasing openness of the capital account, many economic agents will engage in currency speculation, which can often generate speculative profits at the expense of the central bank and (ultimately) the exchequer.


India's Current Exchange Rate 1 INR = 0.0225 USD 1 USD = 44.4548 INR

Indian Rupee vs American Dollar graph

Key Trends in Globalization It is an error to think globalization is purely an economic process - it has deep social, cultural and environmental consequences..

06 January 2010 Decline of the Rupee's exchange rate - India moves further towards the 'Asian growth model' India was one of a number of countries that experienced major currency devaluation against the dollar during and after the international currency crisis. As the comparison to China, which pursued a policy of stabilizing the RMB's exchange rate against the dollar after the outbreak of the financial crisis, is particularly interesting the movements of the RMB and the Indian Rupee against the dollar since 2000 are shown in Figure 1.


Figure 1

As may be seen the Rupee from 2000 up to September 2007 had a tendency to a weaker exchange rate than the RMB. But the difference was not extreme and in September 2007 the two currencies were essentially at parity in terms of exchange rate shifts with a roughly ten percent upward movement in exchange rate against the dollar compared to 2000. After September 2007, however, a marked divergence between the exchange rate of the RMB and the Rupee began. The RMB first continued to rise and then stabilized, without falling, when the financial crisis began. The exchange rate of the Rupee, in contrast, starts falling from September 2007 onwards and this accelerated as the financial crisis developed. The specific trends since the start of the financial crisis are shown in Figure 2


Figure 2

Taking these movements together, between September 2007 and January 2010 the RMB rose by over 10% against the dollar while the Rupee fell by over 20% between September 2007 and its low point in March 2009. Even after recovery of the Rupee, at the beginning of January 2010 it was still more than 12% below its September 2007 level. As the RMB went up against the dollar in the same period this means that the Rupee has carried out an effective twenty per cent devaluation against the RMB since September 2007. Given that India runs, relative to the size of its economy, a containable balance of payments deficit, which in 2008 was 2.7% of GDP, no substantive internationally destabilizing consequences flow from the devaluation of the Rupee against either the dollar or the RMB. What will be significant however will be to see whether this clear devaluation of the Rupee against the RMB alters the relative dynamics of India's and China's economies. As this blog has noted on a number of occasions the long term effect of India's economic reforms has been to shift it decisively towards the 'Asian growth model' - that is to a very strong increase in savings and investment rates. Indian Prime Minister Man Mohan Singh has consciously supported this policy. The decline of the exchange rate of the Rupee moves India further towards adoption of the 'Asian growth model'. This is because for countries such as South Korea and China a second


component of their economic strategy, alongside high rates of savings and investment, was to maintain a low exchange rate in order to boost exports. Contrary to accusations to the contrary this did not necessarily mean running a large trade surplus, as this depended on developments such as the rate of growth of the economy which helped determine whether imports rose equally - for example China's large trade surplus appeared only in 2005 and is now declining, while South Korea at various times has run large trade deficits. The low exchange rate policy, however, did ensure a rapid development of the share of exports in the economy, allowing economies of scale from production for the international market and other benefits to be achieved. The fact that India was more cut off from the international division of labour compared to is east Asian competitors, that is its share of exports and imports in the economy was relatively low, was an achilles heel. Having achieved a level of savings and investment which is currently higher than South Korea and the other former East Asian tigers, and is not far behind China, the logical next step for India is to adopt a low exchange rate policy to stimulate exports still further. The changes in the Rupees exchange rate in the last period give the opportunity to achieve this. It remains to be seen whether they will be consolidated. In addition to the importance for India itself there is an international significance of India's further shift towards a policy of a high savings and high investment coupled with a low exchange rate to stimulate exports. For this, as noted, is precisely the 'Asian growth model'. The fact that the world's second most populous country, soon to become its first, is moving with success further towards such a model has clear implications. Far from the 'Asian growth model' moving to its end after the financial crisis, as some commentators have claimed, it is spreading further. Watching the exchange rate of the Rupee, and its effect on India's economic performance, is becoming a highly important international issue.


Indian Rupee (INR) Exchange Rate Forecast As with all currencies, the Indian Rupee or INR exchange rate has been affected by the current economy. However, in looking at what forecasters are saying for 2010, the Rupee will hit an average over the 12-month period of 49.05 compared to the US dollar. Now, most forecasters agree that by the end of March, the Indian Rupee will see a small decline, perhaps to 45.55, but some believe that an increase to as much as 52.55 is possible.

When looking at the average for the Indian Rupee in February of 2010, the average hit 46.27, which is actually 37.9 basis points greater than what numbers showed for the month of January. However, in looking at the Indian Rupee overall, basis points for just one year prior were 298 lower. Even though the Indian Rupee has dropped over the past 12 months along with many other currencies, forecasters are staying cautiously optimistic. On a positive note, when compared to the US dollar, the Rupee is not making any dramatic moves, instead staying somewhat flat.

Because of this, experts believe if the current trend stays the course, the average by the end of March for the Indian Rupee will be 46.65. Now the thing to remember is that when looking at long-term trends, meaning over the past 12 months, the average was 45.53. Therefore, if the Rupee were to hit 46.65 at the end of March 2010, it is actually higher. Although this indicator is not a huge difference, it is certainly better than being less than the past 10-year average.

Look at the situation with the Indian Rupee this way. From 1973 to 2009, the average exchange rate with the US dollar was just below 23.00. Then, considering that since that time the highest rate the Rupee has ever hit was 51.13, things are not looking too bad. Although at one point in the past 35 plus years the Indian Rupee dipped to 7.27, it is easy to see that this dramatic decline was more the exception and not the rule. This means overall, the Rupee has held its own.


Before investing, it is advised that investors and consumers look at current charts although forecasters are not expecting anything major to occur. Remember, all currencies have been dealt hard blows, some worse than others but when looking at short and long-term trends specific to the Indian Rupee Exchange Rate, there is some peace of mind knowing this particular country is not among those suffering the most.

Forecasters have done a great job when it comes to the Indian Rupee exchange rate versus the US dollar. For instance, it was predicted that for March 2010, the rate would hit at 49.00. When looking at the Historical Data Test Forecast Accuracy or HDTFA, this number was right on target. On March 6, 2010, the exchange rate settled at 46.27, with a gradual increase. Therefore, from all indicators it appears forecasts for the Indian Rupee to the US dollar is spot on.


Currency Basket

What Does Currency Basket Mean?

A selected group of currencies in which the weighted average is used as a measure of the value or the amount of an obligation. A currency basket functions as a benchmark for regional currency movements - its composition and weighting depends on its purpose.

Currency baskets are collections of securities with a weighted average that can be utilized to calculate the current value of any given debt, duty, or written promise. Securities of this type may also be used to determine the current value of a currency that is different from the currency involved with the security under consideration. Generally, the use of a currency basket to evaluate the current value of a currency will involve considering several different currencies in order to obtain an average performance value over a broader scope.

The use of a currency basket can be very important for investors who wish to deal with currency exchange as a way of increasing their net worth. In general, the process of evaluating one currency against a different currency is known as pegging. For example, an investor may choose to compare the current value of the United States dollar to the Euro. While this approach works well when considering an exchange that only involves these two currencies, it does not address the possible advantages in exchanging one base currency for several different currencies. With a currency basket, the comparison is broader and thus may yield two or more possible approaches to the execution of a Forex order.

A currency basket can also be an important factor for the countries who issue currency as well. Pegging the currency by comparing the current rate of exchange with several different prominent and desirable currencies can provide a lot of insight into all sorts of important aspects. Through the application of the currency basket approach, it is possible to get some perspective on the general opinion of a country, its political situation, and the willingness of other countries to do business with the nation in question.

Dealers who advise investors on currency trading and who often place the orders on behalf of investors will also play close attention to the current status of a currency basket composed of


major currencies from around the world. The relationship between the currencies in a given currency basket can provide some valuable clues about future movements, which in turn will help investors side step deals that are not likely to pan out.

Pegging the currency by comparing the current rate of exchange with several different prominent and desirable currencies can provide a lot of insight into all sorts of important aspects. Through the application of the currency basket approach, it is possible to get some perspective on the general opinion of a country, its political situation, and the willingness of other










Most domestic monetary policies, in fact, ignored the effects of the currency basket, as the transactions relative to domestic money supplies were insignificant.


Liberalized Exchange Rate Management System — The story of India's Gulf crisis A. Seshan As always, victory finds a hundred fathers, but defeat is an orphan. — Count Galeazzo Ciano, The Forex Crisis JULY 12, 1991, was a red-letter day in the history of the Indian economy but not in any happy sense. It marked the nadir in the external sector. The balance-of-payments bottom line was reached. The foreign currency assets of the Reserve Bank of India (RBI) amounted to $975 million. And the limited reserves were not fully in the central bank's custody. An amount of $600 million was kept with the State Bank of India, New York, for reasons given later. Effectively the foreign currency assets available with the RBI were adequate to meet the cost of a week's imports against the desirable norm of three months. From that abysmal position we have reached a level of about $130 billion in foreign currency assets today and suffer from an embarrassment of riches. In recent years, a number of articles have appeared in newspapers and journals on the story of economic reforms in India. Many writers have identified the members of the `A team' which ushered in the reforms leading to the benign situation now. There are others who were silent witnesses to all that was happening, although not a part of the `A Team'. They also have a story to tell. How default was averted In the first place, it was only indirectly because of Saddam Hussein that India woke up to realities. For, the crisis was long in coming. Saddam Hussein's aggression on Kuwait and the events that followed them aggravated India's problems, making it imperative to find solutions. There was also the instability at the Centre and the Chandrasekhar formed a government with the support of the Congress.


The political instability was a blessing in disguise. It was engaged in a game of `life-anddeath', and such mundane matters as the forex crisis were left to the central bank. A point was reached when there was a good possibility of the country defaulting on one of its repayment instalments. Borrowing from the market was out of the question, given the junk status accorded to Indian bonds by the rating agencies. The major item of import finance related to oil. Indian Oil Corporation was the canalising agency and it needed money. The SBI arranged for short-term Acceptance Credit in the interbank market in New York, which was just rolled over from day to day. It was then that RBI decided to keep $600 million with SBI in New York, as a contingency reserve for making import payments. Under such circumstances the central bank came up in July 1991 with the bold proposal of pledging its gold stocks to Bank of England and Bank of France and raise a short-term loan of $405 million. It was fully aware of the likely political fallout and the criticism that the country's jewels were being pawned. The whole operation of physically transporting the stocks to London was carried out in secret under the close supervision of a Deputy Governor, who was in constant touch with the officer going in the truck to the airport. The gold was subsequently redeemed through repayments between September and November 1991. But what is not known to the public is the fact that in the process of refining the gold to meet international standards before its pledge there was a value addition which was most welcome at a critical time. The reforms India applied for IMF assistance. It was clear that in its absence the other avenues for raising resources would be closed. The IMF sent its `A team' to India to discuss its conditionalities for lending, the elements of which are well known as the Washington Consensus.


The economic reforms were thus introduced because of the IMF conditionalities and not because of any sudden change of economic philosophy by the Government. Of course, some official economists claimed that it was all the Government's own policy but blessed by the IMF/World Bank. There was a hectic period of the announcement of reforms by the newly-formed Government of P. V. Narasimha Rao, encompassing practically all aspects of economic policy. Depreciation of rupee The RBI's first major announcement was the depreciation of the rupee, in two instalments — on July 1 and 3, 1991. It was euphemistically called a "downward adjustment" of the value of the rupee and the first instalment was stated to be to "test the waters". The value of the rupee declined by 18-19 per cent against major currencies to improve the competitiveness of Indian exports. The Index of Real Effective Exchange Rates was used in policy formulation. However, it is no longer the deciding criterion for the central bank, given its limitations. The markets were then taken by surprise, as there had been no inkling of such a large depreciation of the currency.


LERMS There was an urgency to overhaul the administered exchange rate system. The RBI Governor formed an internal group with the members being O. P. Sodhani, Controller, Exchange Control Department; P. B. Kulkarni, Chief Officer, Department of External Investments and Operations, and this writer, who was Adviser (International Finance), as Convener. There were inquisitive colleagues who were anxious to know what was going on and would have liked to get into the act. We successfully kept our meetings and discussions confidential, often without any documents but only hand-written notes. The Governor indicated the terms of reference orally. We met on a few occasions and recommended the Liberalized Exchange Rate Management System (LERMS), which was approved by the Governor, and subsequently incorporated in the report of the High Level Committee on Balance of Payments. LERMS introduced, from March 1992, a dual exchange rate system in the place of a single official rate. It consisted of one official rate for select government and private transactions and the market-determined rate for the others. It treated current and capital transactions in different ways. There were requirements of surrender of foreign exchange by the public to banks with some exceptions. The working of LERMS was smooth from the beginning, contrary to the fears in some quarters that the rupee may undergo a steep depreciation. Some experts expected a market rate of Rs 50 per dollar. When the scheme was introduced, forex dealers felt like prisoners of half a century being suddenly released one morning and not knowing what to do, having lost all moorings in life! However, they adjusted to the new situation quickly. The RBI announced the official rate. The Foreign Exchange Dealers Association of India (FEDAI) intimated the market rate, called the Indicative Rate, to the Authorized Dealers (ADs) for dollar, mark, yen and pound sterling at noon every day.


The ADs were free to quote their own rates but, by and large, they were close to the FEDAI rates. The spread, measured as the difference between the official rate and the market rate as a percentage of the former, ranged between 10.2 per cent and 15.8 per cent for ten days between March 3, 1992, when the FEDAI announced the Indicative Rate for the first time, and March 13. The stability of the spread was ensured by several factors. In the first place, there was a marked improvement in NRI remittances through the banking channel, particularly from the Gulf, in view of the facility to convert dollars into rupees at market rate to the extent of 60 per cent. It was also the result of the Government permitting gold imports up to 5 kg by NRIs and other returning Indians, once in six months. More than 90 tonnes were brought into the country before the end of December 1992. The decision to permit gold imports was linked to LERMS. It was part of the RBI's package of measures for the external sector. The Apex Bank was felt that as long as gold imports were not permitted the hawala market in foreign exchange would prevail. It was well known that the demand for dollars in the unofficial market was linked to the financing of gold smuggled into the country. With a rising supply in the domestic market the margin for the smuggler came down drastically from Rs 1,414 per 10 grams on April 17, 1992, before the reduction in import duty, to Rs 676 per 10 grams on December 24, 1992 marking a fall of 52 per cent. The trend in the decline in the profit continued and it was no longer attractive for the smuggler to engage in illegal activity. The depreciation of the rupee against the dollar vis-à -vis the official rate ranged between 25 and 30 per cent in February 1992 (before LERMS was introduced) in Hong Kong, New York, Frankfurt, Dubai and other places where the currency was traded unofficially. At the end of 1992 the rate came down to Rs 32 to a dollar — a depreciation of 4 per cent over the market rate and 10 per cent over the weighted average rate of official and market


rates. It made the hawala transaction no longer attractive to the NRIs, who preferred the banking channel for routing remittances to their families. The RBI's foreign currency assets maintained a rising tend. They reached a level of $5.6 billion on March 31, 1992, rising from $975 million on July 12, 1991. After accounting for assistance received from bilateral and multilateral agencies, receipts under India Development Bond Scheme and Remittances in Foreign Exchange (Immunities) Scheme 1991, about $1 billion remained to be explained. It was essentially the result of reforms in the exchange rate system leading,inter alia, to faster repatriation of export receipts and routing of remittances through banking channels. From April 1, 1991 till March 31, 1992 purchases by the RBI from the ADs amounted to $1.8 billion against the net sales of $5.8 billion the previous year implying a turnaround of $7.6 billion. LERMS had its detractors too. The export community considered the 40:60 rule as a tax on their profession. But it was envisaged as a transitory measure and to help avoid a sudden increase in government expenditure, fiscal deficit and inflation rate. In the next Budget a unified floating rate based on market forces was introduced which continues till today. What has been written in this article just skims the surface of the whole crisis. The central bank has been undertaking a history project, and two volumes (1935-51 and 1951-67) have been published. After the preparation of the third volume covering 1967 to 1982, which awaits publication, the bank disbanded the History Cell. It looks like the next volume may take time.


Liberalized Exchange Rate Management System (LERMS) In view of the continuing pace of liberalization policy, the Liberalized Exchange Rate Management System (LERMS) has assumed a special significance in the arena of international financial management. Already the rupee has been made fully convertible on current account. The main objective of the Government is to move the rupee finally into the era of full convertibility to boost exports. The Government in this connection issued memorandum of LERMS. The basic features of LERMS can be stated as follows: 

The exchange rate of the rupee will be determined purely on the basis of market forces of demand and supply. It may, therefore, also could be described as ―market determination exchange rate system‖.

All receipts whether on current or capital account and of the balance of payments and whether on government or private account will be converted entirely at the market rate of exchange.

NRIs will be permitted to maintain the Residents Foreign Currency Account (RFCA) to which the entire foreign exchange brought in by them will be credited. Moreover, those Indians who get receipts from abroad now can have the benefit of getting the entire foreign currency credit to them at the market rate.

Exporters and the recipients of inward remittances are required to surrender the foreign currency received by them to the authorized dealers in foreign currency. However, they are allowed to maintain 15% of the receipts, in foreign currency account with an authorized dealer.

There is no obligation on the authorize dealers to sell any portion of their foreign currency receipts direct to the Reserve Bank as was the case so far. They can sell the receipts in the Indian Market either to other authorized dealers or for any permissible transactions.

Foreign currency remittances abroad are subject to the exchange control regulations, Of Course, it does not mean that the Reserve Bank of India's permission would be required in every case.

The intervention currency of the Reserve Bank continues to be US Dollar. It may at its discretion buy and sell US dollars from/to various authorized dealers.


Modified Liberalized Exchange Rate Management System (Modified LERMS)

The process of liberalization continued further and it was decided to make the Rupee fully floating with effect from March 1, 1993. The new arrangement is called Modified Liberalized Exchange Rate Management System or Modified LERMS. Its salient features are as under: Effective March 1, 1993, all foreign exchange transactions, receipts and payments, both under current and capital accounts of balance of payments are being put through by authorized dealers at market determined exchange rates. Foreign exchange receipts and payments, however, continued to be governed by Exchange Control Regulations. Foreign exchange receipts are to be surrendered to the authorized dealers except in cases where the residents have been permitted by RBI to retain them either with the banks in India or abroad. Authorized dealers are free to retain the entire foreign exchange surrendered to them for being sold for permissible transactions and are not required to surrender to the Reserve Bank any portion of such receipts. Reserve Bank of India, under Section 40 of RBI Act, 1934, was obliged to buy and sell foreign exchange to the authorized dealers. Reserve Bank is now required to sell any authorized person at its offices/branches US Dollars for meeting foreign exchange payments at its exchange rates based on the market rate only for such purposes as are approved by the Central Government. The RBI buys spot US Dollars from authorized dealers at its exchange rate. Reserve Bank does not ordinarily buy spot Pound Sterling, Deutsche Mark and Japanese Yen. It does not buy forward any currency. The exchange rate at which the RBI buys and sells foreign exchange is in the ± 5% band of the market rate. Also, the RBI announces the reference rate at 12:00 hours which is the rate at which transactions with IMF/IBRD etc. are undertaken.

Advantages of the New System 

The system seeks to ensure equilibrium between demand and supply with respect to a fairly large subset of external transactions.

It has facilitated removal of several trade restrictions and granted relaxation in exchange control (under current account transactions).

It is a step towards full convertibility of current account transactions in order to achieve the full benefits of integrating the Indian economy with the world economic system.

34 

The incentives to exporters will be higher and more particularly to those whose exports are not highly import intensive. Exporters of agricultural products will find exports attractive.

A large number of expatriates, who are hitherto denied any advantages on their remittances to India in line with the earnings of the exporters, are now eligible for market rate for the full amount of remittances being in the nature of capital inflows.

This system, coupled with the exchange control relaxation in certain areas, and the abolition of travel tax is expected to make the havala route less tempting. In this context it needs to be remembered that smaller the gap between the average rate received by the exporters and other earners of foreign exchange and the market rate, the lesser will be the temptation to continue using illegal channels for remittances. In the fiscal area, customs revenue is likely to be higher, other things being the same, to the extent the valuation of imports would be based on the market exchange rate. It is, however, necessary to ensure that the tariff rates together with higher input values do not result in a sharp increase in import costs.

THE EXPERT GROUP ON FOREIGN EXCHANGE MARKETS IN INDIA - BY SODHANI COMMITTEE Some important recommendations of the Committee regarding forex markets are as under: 1) Corporates should be permitted to take hedge upon declaring the existence of a genuine exposure. 2) The banks may be permitted to decide upon open position limits subject to their earmarking capital to the extent of 5% of open exposure limits. 3) The discipline relating to aggregate gap limit should ideally encompass rupee transaction also. 4) A Ds may be permitted to initiate cross currency positions abroad. 5) Banks should be allowed to lend/ borrow short term funds up to six months in the overseas markets.’ 6) Number of participants in the forex markets should be increased by permitting financial institutions like IDBI.IFCI etc., to trade in the forex market.


7) Market intervention by Reserve Bank should be on selective basis. 8) Banks should have freedom to decide interest rates and maturity period of FCNR(B) deposits subject to cap being put in place of RBI. 9) Exporters should be allowed to retain 100% foreign exchange earnings in India. 10) Corporates should be allowed to cancel and re-book option contracts. 11) Banks should be permitted to offer lower cost option strategies like ―Range Forwards‖ and ―Ratio Range Forwards‖. 12) Banks should have greater freedom to use derivative products for their own asset-liability management. 13) Banks should be given general permission to offer hedging products caps, floors, swaps, etc. 14) Corporates having EEFC accounts should be allowed margin trading by using the balances in their EEFC accounts.

COMMITTEE ON CAPITAL ACCOUNT CONVERTIBILITY -TARAPORE COMMITTEE Some of the key recommendations of the committee were: 

Exchange Rate of Rupee

Credibility of Exchange Rate Policy

Balance of Payments

Adequacy of Reserves

Reduction in gross fiscal deficit from 4.5% in 1997-98 to 3.5% of GDP in 1999-2000

Maintain inflation for the period 1997-98 to 1999-2000 at 3% to 5%

36 

Gross NPAs of the public sector banks to be brought down from 13.7% in 1997-98 to 5% by 2000


Average effective cash reserve ratio (CRR) to be brought down from 9.3% to 3% by 2000

Impact of Capital Account Convertibility After full convertibility is adopted by India, it will lead to acceptance of Indian Rupee currency all over the world. In case of two convertible currencies, Forward Exchange Rates reflect interest rate differentials between these two currencies. Thus, we can say that the Forward Exchange Rate for the higher interest rate currency would depreciate so as to neutralize the interest rate difference. However, sometimes there can be opportunities when forward rates do not fully neutralize interest rate differentials. In such situations, arbitrageurs get into the act and forward exchange rates quickly adjust to eliminate the possibility of risk-less profits. Capital account convertibility is likely to bring depth and large volumes in long-term INR currency swap markets. Thus for a better market determination of INR exchange rates, the INR should be convertible.


CONCLUSION: The rupee exchange rate is neither completely free-floating nor fixed, but is ―managed‖ by the Reserve Bank of India through buying and selling other currencies. the Reserve Bank found itself having to spend more and more on foreign currencies just to keep the rupee stable. Convertibility of Rupee will give pleasure to the 10 percent of Indian people who are either rich or upper middle class, traders in the stock market, speculators, bankers, and accountants. The rest 90 percent of the people will be adversely affected with loss of employments in the manufacturing sector and bankruptcy in the agricultural sector and total economic uncertainly. In any democratic country for any serious matter like turning the Rupee into a convertible currency there must be referendums. There were referendums in each and every European country when they wanted to create the European monetary system whereby each European currency would be aligned to each other to create a common currency Euro. Although India claims to be a democracy, Indian policy makers try their best to avoid the public opinion, even the parliament. Major issues like India’s membership of the World Trade Organization, abolition of the planned economy and privatization of public assets, free trade, and now the convertibility of Rupee should be debated in the parliament and people of India should be allowed to give their verdict in referendums if India wants to be a true democracy. The strengthening rupee may also send an even more important signal: India is not China. Of course, the Reserve Bank could still intervene to push India’s rupee lower again. But both the anonymous government official warning of rupee-related job losses and investors see the rupee continuing to rise in the coming months. If that happens expect to hear a lot more bleating from India’s exporters — and not a word of complaint from India’s trading partners around the world. Capital account convertibility is considered to be one of the major features of a developed economy. It helps attract foreign investment. It offers foreign investors a lot of comfort as they can re-convert local currency into foreign currency anytime they want to and take their money away.


At the same time, capital account convertibility makes it easier for domestic companies to tap foreign markets. At the moment, India has current account convertibility. This means one can import and export goods or receive or make payments for services rendered. However, investments and borrowings are restricted.

But economists say that jumping into capital account convertibility game without considering the downside of the step could harm the economy. The East Asian economic crisis is cited as an example by those opposed to capital account convertibility. Even the World Bank has said that embracing capital account convertibility without adequate preparation could be catastrophic. But India is now on firm ground given its strong financial sector reform and fiscal consolidation, and can now slowly but steadily move towards fuller capital account convertibility.


BIBLIOGRAPHY: 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14)