Discovery, Volume 23, Number 78, September 4, 2014
DEMONETIZATION OF INDIAN RUPEE AGAINST US $:
A HISTORICAL PERSPECTIVE
ABSTRACT
The Indian Rupee exchange rate depreciated 5.71 percent against the US dollar during the month of November. During the last 12 months, the
Indian rupee exchange rate depreciated 14.27 percent against the US dollar. Historically, from 1973 until 2011 the USD/ INR exchange averaged
30.32 reaching an historical high of 52.84 in December of 2011 and a record low of 7.19 in March of 1973.India may face its worst financial
crisis in decades if it fails to stem a slide in the rupee, leaving the central bank with a difficult choice over how to make the best use of its limited
reserves to maintain the confidence of foreign investors. The fall in the value of Indian rupee has several consequences which could have mixed
effects on Indian economy. This paper tries to study the reasons for Demonetize of pre liberalization era and post liberalization that is of the year
2011. It also attempts to study the real implications of the depreciation of the rupee on the Indian economy and shows that in the long run, the
Indian economy has more to lose and less to gain with weaker rupee. In this paper effort has been made to highlight on the importance of central
bank intervention to control this situation.
I. OBJECTIVES OFTHE STUDY
1) To know about the trend of Indian Rupee and it exchange rate against us $ historically.
2) To understand the concept of Demonetize.
3) To understand the causes and the steps taken by government on the major Demonetizes that took place in India.
4) To study the real implications of the depreciation of the rupee on the Indian economy.
II. INTRODUCTION
Demonetize means a fall in the value of domestic currency in terms of foreign currency/currencies. For example, suppose the exchange rate
between rupee and dollar is Rs 50= 1 $. If this exchange rate is fixed at Rs. 55= 1$ then it is called demonetize/ devaluation of rupee. Earlier
Rs.25 could purchase a dollar and now more rupees (rs.30) are required to get a dollar. So the value of rupee in terms of dollar has declined.
Real Implications of Demonetize
a) It helps to boost exports.
b) It will lead to higher cost of imported goods and make some of the capital extensive projects more expensive to execute.
c) It will increase cost of dollar loans taken by companies and increase foreign debt.
d) It will slow down the overall economic growth by increasing the interest rates and dissuade flow of FII’s.
III. HISTORYABOUT INDIAN RUPEEAND ITS EXCHANGE RATE WITH US $
From 1950 to 1973 Indian rupee was linked to British pound. In 1966 and 1973 Demonetize happened. On 24th September 1975, the connection
between Indian rupee and pound was broken. In 1975, the rupee ties to the pound sterling were disengaged. India established a 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.
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Sunita,
Demonetization of Indian rupee against us $: A historical perspective,
Discovery, 2014, 23(78), 108-112, www.discovery.org.in
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Discovery, Volume 23, Number 78, September 4, 2014
In 1993 Liberalized exchange rate system (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 and control the Indian
currency.
Indian rupee and its exchange rate historically.
1950 – 4.79 Indian rupee to 1 American dollar
1955 – 4.79 Indian rupee to 1 American dollar
1960 – 4.77 Indian rupee to 1 American dollar
1965 – 4.78 Indian rupee to 1 American dollar
1970 – 7.56 Indian rupee to 1 American dollar
1975 – 8.39 Indian rupee to 1 American dollar
1980 – 7.86 Indian rupee to 1 American dollar
1985 – 12.36 Indian rupee to 1 American dollar
1990 – 17.50 Indian rupee to 1 American dollar
1995 – 32.42 Indian rupee to 1 American dollar
2000 – 44.94 Indian rupee to 1 American dollar
2005 – 44.09 Indian rupee to 1 American dollar
2010 – 44 to 50 Indian rupees to 1 American dollar
Before 2011 India had faced two major demonetize that is in the year 1966 and 1991. So let’s understand the reasons and the measures adopted
by government for the major demonetizes that took place in India.
IV. THE 1966 DEMONETIZE
As a developing economy, it is to be expected that India would import more than it exports. Despite government attempts to obtain a positive
trade balance, India has had consistent balance of payments deficits since the 1950s. The 1966 devaluation was the result of the first major
financial crisis the government faced.
Causes
a) Increasing trade deficit:
Despite government attempts to obtain a positive trade balance, India suffered a severe balance of payments deficits since the 1950s. Inflation
had caused Indian prices to become much higher than world prices at the pre-devaluation exchange rate. When the exchange rate is fixed and a
country experiences high inflation relative to other countries, that country’s goods become more expensive and foreign goods become cheaper.
Therefore, inflation tends to increase imports and decrease exports. Since 1950, India ran continued trade deficits that increased in magnitude in
the 1960s.
b) India’s war with Pakistan in late 1965
The US and other countries friendly towards Pakistan, withdrew foreign aid to India, which further necessitated devaluation. Because of all these
reasons, Government of India devalued Rupee by 36.5% against Dollar.
Steps taken by government
a) Imposed Quantitative Restrictions:
The government used the method of QRs with varying levels of severity until the Import- Export Policy of 1985-1988. Periodically, when import
prices reached a premium, the government would impose import tariffs in order to absorb the gains accruing to foreign exporters as a result of
India’s import
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b) Provided export Subsidies
Government began to subsidize exports in an effort to further narrow its consistent current account.
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Demonetization of Indian rupee against us $: A historical perspective,
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Discovery, Volume 23, Number 78, September 4, 2014
V. THE 1991 DEMONETIZE
1991 is often cited as the year of economic reform in India. Surely, the government’s economic policies changed drastically in that year. Then the
Import-Export 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.
Causes
a) The trade deficit in 1991 was US $9.44 billion.
b) The current account deficit was US $9.7 billion.
c) The gulf war led to much higher imports due to rise in oil prices.
d) Cost pulls inflation.
e) Political and economical instability.
f) Depleting foreign exchange reserve.
Steps taken by government
a) Establishing a dual exchange regime:
In March 1992 the government decided to establish a dual exchange rate regime and abolish the EXIM scrip system. Under this regime, the
government allowed importers to pay for some imports with foreign exchange purchased at a government-mandated rate.
b) Followed a floating exchange rate system”
In March 1993 the government then unified the exchange rate and allowed, for the first time, the rupee to float. From 1993 onwards, India has
followed a managed floating system, the exchange rate is determined ostensibly by market forces but the Reserve Bank of India plays a
significant role in determining the exchange rate by selecting a target rate and buying and selling foreign currency in order to meet the target.
VI. THE 2011 DEMONITIZATION
The point is that will 2011 demonize will be considered a major demonotiz in the history of India with a much deeper impact.
It was Rupee 43.96 against a dollar in the march end and now for $1 is is rupees 64.3
Causes
a) Withdrawal of FII’s:
Foreign Institutional investor’s withdrawal from domestic economy is the one big reason for this depreciation.
b) Strengthening of Dollars:
The Euro-Zone crisis has weakened the Euro significantly against the US Dollar. In other words dollar is getting stronger in the world markets.
Obviously the investors are considering US a safe place to invest in.
c) Other capital flows:
On month by month basis, FDI, ECB’s and Foreign Currency Convertible Bonds (FCCBs) recorded a slowdown in Financial Year 2011.
c) Indian Politics
d) Number of Indian scams distracted government’s concentration away from economy.
All these scams make the bad image of India in the global market.
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Policy options with RBI to control Demonetize of rupee:
a) Raising Policy rates:
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Demonetization of Indian rupee against us $: A historical perspective,
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Discovery, Volume 23, Number 78, September 4, 2014
The rationale was to prevent sudden capital outflows and prevent meltdown of the currencies. In India’s case, this cannot be done as RBI has
already tightened policy rates significantly since Mar-10 to tame inflationary expectations. Higher interest rates along with domestic and global
factors have pushed growth levels much lower than expectations. In its Dec-11 monetary policy review, RBI mentioned that future monetary
policy actions are likely to reverse the cycle responding to the risks to growth. India’s interest rates are already higher than most countries
anyways but this has not led to higher capital inflows. On the other hand, lower policy rates in future could lead to further capital outflows.
b) Using FOREX Reserves:
RBI can sell forex reserves and buy Indian Rupees leading to demand for rupee. Based on weekly forex reserves data (Figure2), RBI seems to be
selling forex reserves selectively to support Rupee. Its intervention has been limited as liquidity in money markets has remained tight in recent
months and further intervention only tightens liquidity further.
c) Easing Capital Controls:
Dr Gokarn Deputy Governor of RBI said in his speech capital controls could be eased to allow more capital inflows. He added that “resisting
currency depreciation is best done by increasing the supply of foreign currency by expanding market participation.
Steps taken by Government
a) Increased the FII limit on investment in government and corporate debt instruments.
b) First, it raised the ceilings on interest rates payable on non-resident deposits. This was later deregulated allowing banks to determine their own
deposit rates.
c) The all-in-cost ceiling for External Commercial Borrowings was enhanced to allow more ECB borrowings
Administrative measures:
Apart from easing capital controls, administrative measures have been taken to curb market speculation.
a) Earlier, entities that borrow abroad were liberally allowed to retain those funds overseas. They are now required to bring the proportion of
those funds to be used for domestic expenditure into the country immediately.
b) Earlier people could rebook forward contracts after cancellation. This facility has been withdrawn which will ensure only hedgers book
forward contracts and volatility is curbed.
c) Net Overnight Open Position Limit (NOOPL) of forex dealers has been reduced across the board and revised limits in respect of individual
banks are being advised to the forex dealers separately.
VII. CONCLUSION
Thus we can see that since 1950 besides few appreciation rupee is depreciating against US dollar and the causes of depreciation are invariable
different. Even after taking few measures by government if we see the recent depreciation, Rupee depreciation has abated but it still remains
under pressure. Both domestic and global conditions are indicating that the downward pressure on Rupee to remain in future. Thus, RBI should
likely to continue its policy mix of controlled intervention in forex markets and administrative measures to curb volatility in Rupee. Apart from
RBI, government should take some measures to bring FDI and create a healthy environment for economic growth. Some analysts have even
suggested that Government should float overseas bonds to raise capital inflows.
VIII. REFERENCES
1) Johri Devika, Miller mark. “Demonetize of the Rupee: Tale of Two Years, 1966 and
1991.” State, Market & Economy 84-90
2) Aggarwal Anmol. “Rupee Depreciation: Probable Causes and Outlook.” STCI Primary
Dealer Ltd 21 Dec 2011:1-9
111
3) Sumanjeet Singh (2009). “Depreciation of the Indian Currency: Implications for the
Indian Economy.” AIUB Bus Econ Working Paper Series, No 2009-04,
Page
4) Swati Bhatt (2011). Big dangers from a declining rupee.” The NEW York times
Sunita,
Demonetization of Indian rupee against us $: A historical perspective,
Discovery, 2014, 23(78), 108-112, www.discovery.org.in
http://www.discovery.org.in/d.htm © 2014 Discovery Publication. All Rights Reserved
Discovery, Volume 23, Number 78, September 4, 2014
----------------------------------------------------------------------------------------------------------------------
Name: R. SUNITA
Programme: RESEARCH SCHOLAR-FULL TIME
University : ANNA UNIVERSITY CHENNAI-600025
E-mail: Sunitajohn10@yahoo.com
Phone no: 9003134002
Res. Address: R. Sunita John
F3, 11/6, sree veera apartment,
Thiruvallur street, Metha nagar,
Aminjikari (p.o), Chennai-600029,
Tamilnadu.
GUIDE: Dr. Hansa Lysander Manohar
Associate Professor
Management Studies, Anna University,
Chennai. 600025, Tamilnadu.
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Demonetization of Indian rupee against us $: A historical perspective,
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