India’s exchange rate policy has evolved in tandem with the domestic as well as
international developments. The period after independence was marked by a fixed
exchange rate regime, which was in line with the Bretton Woods system prevalent
then. The Indian Rupee was pegged to the Pound Sterling on account of historic links
with Britain. After the breakdown of Bretton Woods System in the early seventies,
most of the countries moved towards a system of flexible/managed exchange rates.
With the decline in the share of Britain in India’s trade, increased diversification
of India’s international transactions together with the weaknesses of pegging to
a single currency, the Indian Rupee was de-linked from the Pound Sterling in September
The exchange rate subsequently came to be determined with reference to the daily
exchange rate movements of an undisclosed basket of currencies of India’s major
trading partners. As the basket-linked management of the exchange rate of the Rupee
did not capture the market dynamics and the developments in the exchange rates of
competing countries fully, the Rupee’s external value was allowed to be determined
by market forces in a phased manner following the balance of payment difficulties
in the nineties.
A significant two-step downward adjustment in the exchange rate of the Rupee was
made in 1991. In March 1992, Liberalised Exchange Rate Management System (LERMS)
involving the dual exchange rate was instituted. A unified single market-determined
exchange rate system based on the demand for and supply of foreign exchange replaced
the LERMS effective March 1, 1993.
The Reserve Bank’s exchange rate policy focusses on ensuring orderly conditions
in the foreign exchange market. For the purpose, it closely monitors the developments
in the financial markets at home and abroad. When necessary, it intervenes in the
market by buying or selling foreign currencies. The market operations are undertaken
either directly or through public sector banks.
In addition to the traditional instruments like forward and swap contracts, the
Reserve Bank has facilitated increased availability of derivative instruments in
the foreign exchange market. It has allowed trading in Rupee-foreign currency swaps,
foreign currency-Rupee options, cross-currency options, interest rate swaps and
currency swaps, forward rate agreements and currency futures.