History of India’s exchange rates
From 1950-1951 till December 1973, India followed an exchange rate regime with Rupee linked to the Pound Sterling, except for the devaluations in 1966 and 1971. When the Pound Sterling floated on June 23, 1972, the Rupee’s link to the British units was maintained; paralleling the Pound’s depreciation and effecting a de facto devaluation.
On September 24, 1975, the Rupee’s ties to the Pound Sterling were broken. India conducted a managed float exchange regime with the Rupee’s effective rate placed on a controlled, floating basis and linked to a “basket of currencies” of India’s major trading partners.
In early 90s, the above exchange rate regime came under severe pressures from the increase in trade deficit and net invisible deficit, which led the Reserve Bank of India to undertake downward adjustment of Rupee in two stages. This adjustment was followed by the introduction of the Liberalized Exchange Rate Management System (LERMS) in March 1992 and the adoption of a dual (official as well as market determined) exchange rate in India. However, such system was characterized by an implicit tax on exports resulting from the differential in the rates of surrender to export proceeds.
Subsequently, in March 1993, the LERMS was replaced by the unified exchange rate system and hence the system of market determined exchange rate was adopted. However, the RBI did not relinquish its right to intervene in the market to enable orderly control.
The foreign exchange market of India was characterized by the existence of both official and black market rates with median premium. However, such black market premium steadily declined.
According to the RBI, “The exchange rate policy in recent years has been guided by the broad principles of careful monitoring and management of exchange rates with flexibility, without a fixed target or a pre-announced target or a band, coupled with the ability to intervene if and when necessary. The overall approach to the management of India’s foreign exchange reserves takes into account the changing composition of the balance of payments and endeavours to reflect ‘liquidity risks’ associated with different types of flows and other requirements".