Exchange rate system is a system where the government fixes a currency’s value against another currency. It is also known as ‘Pegged Exchange Rate System’.
Exchange Rate Reforms
The origination of India’s foreign exchange market came into line with shifts in the exchange rate policies over the last few decades – from a par value system to a peg system and further to float exchange rate system. Post-Independence, the India’s exchange rate was fixed against Pound sterling as intervention currency. The exchange rate of Rupee remained stable during 1966 to 1971 as sterling exchange rate was kept stable by US monetary authority. The major breakdown of Bretton Woods System in 1971 brought heavy competition to all the central banks worldwide and brought magnificent opportunities for market players to trade in currencies. It was during this time that India started trading in currencies.
Reserve Bank of India and the Central Bank of India played a very important role in developing foreign exchange market in India. It regulates the dealings in foreign exchange payments outside India, transfer of securities between residents and non-residents acquisition of foreign securities, export and import of currency notes, etc. The primary objective of exchange controls was to regulate the demand of foreign currency for various purposes within the specified limit.
Gradually with time, trading volumes began to increase which led to the adoption of different guidelines for working of banks involved in Foreign Exchange Business. Accordingly, the guidelines for internal control over Foreign Exchange Business were formulated in 1981. Till early 1990s, the Foreign Exchange Market was highly regulated with restrictions on external transactions, low liquidity barriers to entry and high transaction costs. The control on foreign exchange transactions was then regulated through Foreign Exchange Regulation Act (FERA), which has become one of the largest foreign exchange markets in the world.
FERA was further replaced by FEMA (Foreign Exchange Management Act), 1999. All the powers of Reserve Bank were delegated to authorised dealers in order to release the foreign exchange for various purposes. The reform phase started with the Sodhani Committee in 1994, which made several recommendations to ease the regulations of Foreign Exchange Market. With these recommendations, Clearing Corporation of India Limited was set up in 2001. For further liberalisation of regulations, an internal technical group on Foreign Exchange Market was set up by Reserve Bank in 2005. During this time, recommendations such as freely cancelling and rebooking the forward contract of any tenure, delegating powers of RBI to ADs for allowing corporates to hedge their portfolio in international commodity exchange market and extending the time limit of trading hours of inter- bank foreign exchange market have been implemented.