INTRODUCTION

The worldwide decentralized or over-the-

counter market for currency trading is known
as the foreign exchange market. Every
currency's foreign exchange rate is set by
this market. It covers every facet of
purchasing, selling, and trading currencies at
established or current rates. With an average
daily trading volume of more than $5 trillion
USD, it is by far the largest market in the
world.

The market where foreign currencies are

bought and sold is known as the foreign
exchange market. The price at which one
sells goods overseas is entirely set by this
market. Individuals, businesses, foreign
exchange brokers, commercial banks, and
the central bank are among the buyers and
sellers. The foreign exchange market is a
system, not a physical location, just like any
other market.
1.1 Аim & OBJECTIVES
1.2 RELEVANCE TO THE SUBJECT

Foreign exchange is the trading of different

currencies or units of account. It is important
because the exchange rate, the price of one
currency in terms of another, helps to
determine a nation's economic health and
hence the well being of all the people
residing it.

1.3 METHODOLOGY OF THE STUDY

2.0 PROJECT DETAILS:
2.1 HISTORY

The Foreign Exchange Market was evolved

from the Bretton Woods System, which was a
system of payments based on USD, which
defined all the currencies in relation of the
USD. It was towards the end of the World War
II which made the US Dollar more stable and
was effectively the world currency, a
currency to which other currencies were
pegged. The US Dollar was serving as the
price of gold as it was considered "as good as
gold". This system went on from 1944 to
1971 when the Bretton Woods Agreement
broke down and the modern foreign
exchange was born
2.2 TYPES OF FOREIGN EXCHANGE RATES:

A] Floating Rate

One of the main causes of

currency fluctuations in the foreign exchange
market is the floating rate. One of the most
significant, prevalent, and primary types of
exchange rates is this one. All developed nations'
economies permit free exchange of their
currencies under this. The demand for a nation's
domestic goods and services among foreign buyers
increases when the currency's value declines
because imports become more affordable for
exporters. Only when the economy is robust can
the nation tolerate the volatility. The economy of
the nation can only automatically switch between
domestic and foreign trade when it can meet
demand.

B] Fixed Rates

Fixed exchange rates are used to attract the

foreign investments and to promote foreign trade.
This type of rate is used only by small developed
countries. The purpose of fixed exchange rate
system is to keep a currency's value within a
narrow band. Fixed exchange rates provide greater
certainty for exporters and importers and help the
government maintain low inflation. On the other
hand, monetary policy of the country becomes
ineffective.
[C] Pegged Rates

Pegged exchange rates are

common for underdeveloped countries and
developing countries. It means that the currency of
that. particular economy is pegged to some other
currency or a bunch of other currencies. This
makes their currency more stable as the other
currencies. The Indian Rupee was once pegged to
the Sterling and the US dollar

[D] Managed Floating

A managed floating
exchange rate is a regime that allows an
issuing central bank to intervene regularly in
Foreign Exchange markets in order to change
the direction of the currency's float and shore
up its balance of payments in excessively
volatile periods. This regime is also known as
a "dirty float"

2.3WHY IS THE FOREIGN EXCHANGE MARKET

UNIQUE?

1) Its huge trading volume is one of the highest

in the whole world and is representing the largest
asset class in the world leading to high liquidity

2) It's geographical dispersion- it is spread across

each and every economy in the world.

3) It is functioning 24 hours except for the

weekends

4) A variety of factors affect the exchange rates.

5) As such, it is considered the closest to the
ideal market of perfect competition.

2.4 ADVANTAGES AND DISADVANTAGES OF

FOREIGN EXCHANGE MARKET.

Advantages

1) The forex market is extremely liquid; hence it's

rapidly growing popularity. Currencies may be
converted when bought or sold without causing too
much movement in the price and keeping losses to
a minimum.

2) As there is no central bank, trading can take

place anywhere in the world and operates on a 24-
hour basis apart from weekends.

3) An investor needs only small amounts of capital

compared with other investments.
4) It is an unregulated market, meaning that there
is no trade commission overseeing transactions
and there are no restrictions on trade.
5) In common with futures, forex is traded using a
"good faith deposit rather than a loan. The interest
rate spread is an attractive advantage.

Disadvantages

1)The major risk is that one counterparty fails to

deliver the currency involved in a very large
transaction. In theory at least, such a failure could
bring ruin to the forex market as a whole

2) Investors need a lot of capital to make good

profits because the profit margins on small-scale
trades are very low.

2.5 FINANCIAL INSTRUMENTS FOR FOREIGN

EXCHANGE MARKETS

Simply stated, a Financial Instrument is any type

of a financial medium such as bills of exchange,
bonds, currencies, stocks. etc., that are used for
borrowing purposes in financial markets. When you
are discussing the forex market, the following
entities are designated as financial instruments:
[A]Forwards: It the agreement established between
two parties wherein they purchase, sell, or trade an
asset at a pre-agreed upon price is called a forward
a forward contract. Normally. there is no exchange
of money until a pre-established future date has
been arrived at. Forwards are normally performed
as a hedging instrument used to either deter or
alleviate risk in the investment activity.

[B] Futures: It is a forward transaction that

contains standard contract sizes and maturity
dates are considered futures. Futures are traded
on exchanges that have been created for that
purpose exclusively. Just like with commodity
markets, a future in the forex market normally
designates a contract length of 3 months in
duration. Interest amounts are also included in a
futures contract.

[C] Options: Options are derivatives (financial

instruments whose values fluctuate based on
underlying variables) wherein the owner has the
right to, but is not necessarily obligated to.
exchange one currency for another at a pre-agreed
upon rate and a specified date. When you talk
about options in any form (stock. market, forex, or
any other market), the forex market is the deepest
and largest, as well as the most liquid market of
any options in the world.

[D]Spot: Where futures contracts normally employ

a 3-month time frame, spot transactions
encompass a 48-hour delivery transaction period.
[A]Forwards: It the agreement established between two
parties wherein they purchase, sell, or trade an asset at a
pre-agreed upon price is called a forward a forward
contract. Normally. there is no exchange of money until a
pre-established future date has been arrived at. Forwards
are normally performed as a hedging instrument used to
either deter or alleviate risk in the investment activity.

[B]Futures: It is a forward transaction that contains

standard contract sizes and maturity dates are considered
futures. Futures are traded on exchanges that have been
created for that purpose exclusively. Just like with
commodity markets, a future in the forex market normally
designates a contract length of 3 months in duration.
Interest amounts are also included in a futures contract.
[C] Options: Options are derivatives (financial instruments
whose values fluctuate based on underlying variables)
wherein the owner has the right to, but is not necessarily
obligated to. exchange one currency for another at a pre-
agreed upon rate and a specified date. When you talk
about options in any form (stock. market, forex, or any
other market), the forex market is the deepest and
largest, as well as the most liquid market of any options in
the world.

[D]Spot: Where futures contracts normally employ a 3-

month timeframe, spot transactions encompass a 48-hour
delivery transaction period.

[E]Swap :Currency swaps are the most common type of

forward transactions. A swap is a trade between two
parties wherein they exchange currencies for a pre-
determined length of time. The transaction then is
reversed at a pre-agreed upon future date. Currency
swaps can be negotiated to mature up to 30 years in the
future, and involve the swapping of the principle amount.
Interest rates are not "netted" since they are denominated
in different currencies.

All of these instruments are used by almost each

exporter or importer one way or other in order to
assist the hedging activities. Let us understand this
with the help of an example: A is an Importer from
India and imports goods worth of $10000 from The
United States of America. A doesn't want to bear
any foreign exchange rate fluctuation risk

A goes to a bank(say HDFC Ltd.) and buys $10000 from

there.
The bank will charge a nominal fee in exchange of t the
service and A will have to pay the amount according to the
current exchange rate i.e. 75 amounting to Rs.
7,50,000.Let us assume that the payment terms are of 3
months. News are that the rupee might get depreciated in
the next few moths to Rs 80 a Dollar. But as A has bought
$10000 from HDFC Ltd. from say futures market, He
doesn't have to worry about the fluctuation. After three
months, A's client will receive money from the importer
and get the money
booked as per the exchange rate earlier, ie. 750,000 Rs.
This is the way people hedge their Accrued Incomes.…

2.6 VARIOUS PARTICIPANTS OF THE FOREIGN

EXCHANGE MARKET:

Governments:

Governments have requirements for foreign

currency, such as paying staff salaries and local
bills for embassies abroad, or for arraigning a
foreign currency credit line, most often in dollars,
for industrial or agricultural development in the
third world, interest on which, as well as the capital
sum, must periodically be paid. Foreign exchange
rates concern government because changes affect
the value of product and financial instruments,
which affects the health of a nation's markets and
financial systems.

Banks:
There are different types of banks, all of which
engage in the foreign exchange market to greater
or lesser extent. Some work to signal desired
movement in the market without causing overt
change, while some aggressively manage their
reserves by making speculative risks. The vast
majority, however, use their knowledge and
expertise is assessing market trends for
speculative gain for their clients.

Brokerage Houses:

These exist primarily to bring buyer and seller

together at a mutually agreed price. The broker is
not allowed to take a position and must act purely
as a liaison. Brokers receive a commission from
both sides of the transaction, which varies
according to currency handled. The use of human
brokers has decreased due mostly to the rise of the
inter bank electronic brokerage systems.
International Monetary Market:
The International Monetary Market (IMM) in
Chicago trades currencies for relatively small
contract amounts for only four specific maturities a
year. Originally designed for the small investor, the
IMM has grown since the early 1970s, and the
major banks, who once dismissed the IMM, have
found that it pays to keep in touch with its
developments, as it is often a market leader.

MONEY MARKET

These tend to be large New York commission houses that

are often very aggressive players in the foreign exchange
market. While they act on behalf of their clients, they also
deal on their own account and are not limited to one time
zone, but deal around the world through their agents.

Corporations:

Corporations are the actual end-users of the foreign

exchange. market. With the exception only of the central
banks, corporate players are the ones who affect supply
and demand. Since the corporations come to the market
to offset currency exposure they permanently change the
liquidity of t the currencies being dealt with.

Retail Clients:

This includes smaller companies, hedge funds, companies

specializing in investment services linked by foreign
currency funds or equities, fixed income brokers, the
financing of aid programs by registered worldwide
charities and private individuals. Retail investors trade
foreign exchange using highly leveraged margin accounts.
The amount of their trading in total volume and in
individual trade amounts is dwarfed by the corporation's
anointer bank markets.

Exchange Brokers:

Services of brokers are used to some extent, Forex market

has some practices and tradition depending on this the
residing in other countries are utilized. Local brokers can
conduct Forex transactions as per the rules and
regulations of the Forex governing body of their respective
country.

Overseas Forex market:

The Forex market operates all around the clock and the
market day initiates with Tokyo and followed by Bahrain
Singapore, India, Frankfurt, Paris, London, New York, and
Sydney before things are back with Tokyo the next day

Speculators:
In order to make profit on the account of favourable
exchange rate, speculators buy foreign currency if it is
expected to appreciate and sell foreign currency if it is
expected to depreciate. They follow the practice of
delaying covering exposures and not offering a cover till
the time cash flow is materialized. Other financial
institutions involved in the foreign exchange
market include:

1. Stock brokers Commodity

2. Firms Insurance
3. Companies Charities
4. Private Institutions & Individuals

2.7 CHARACTERISTICS OF THE FOREX MARKETS:

Changing Wealth:

The ratios between the currencies of two countries are

exchange rates in forex. If one currency loss its value in
the market and at the same time the value of the currency
increases this causes the fluctuations in the exchange rate
in foreign exchange market. For Example, over 20 years
ago a single US dollar bought 360 Japanese Yen, whereas
at present 1 US dollar buys 110 Japanese Yen; this
explains that the Japanese Yen has risen in value, and the
US dollar has decreased in value (relative to the Yen). This
is said to be a shift in wealth, as a fixed amount of
Japanese Yen can now purchase many more goods than
two decades ago..

No Centralized Market:

The foreign exchange market does not have a centralized

market like a stock exchange. Brokers in t the foreign
exchange market are not approved by a governing
agency. Business network and operation market of foreign
exchange takes place without any unification in
transaction. Foreign exchange currency trading has been
reformed into a non-formal and global network
organization it consists of advanced information system.
Trader of forex should not be a member of any
organization.

Circulation of work:

Foreign exchange market has member from all the

countries, each country has different geographical
positions so forex operates all around the clock on working
days Monday to Friday every week. Because the time in
Australia is different than in European countries, this kind
of 24 hours operation, free from any time is an ideal
environment for investors. For instance a trader may buy
the Japanese Yen in the morning at the New York market,
and in the night if the Japanese Yen rises in the Hong Kong
market, the trader can sell in the Hong Kong market. More
number of opportunities is available for the forex traders.
In FOREX market most trading takes place in only a few
currencies; the U.S. Dollar ($), European Currency Unit (€),
Japanese Yen (¥), British Pound Sterling (£), Swiss Franc(₣)

2.8 FACTORS AFFECTING MOVEMENT OF

EXCHANGE RATES

Aside from factors such as interest rates and inflation,

exchange rate is one of the most important determinants
of a country's relative level of economic health. Exchange
rates play a vital role in a country's level of trade, which is
critical to every free market economy in the world. For this
reason, exchange rates are among the most watched
analyzed and governmentally manipulated economic
measures. But exchange rates matter on a smaller scale
as well: they impact the real return of an investor's
portfolio. Here we look at some of the major forces behind
exchange rate movements. Before we look at these
forces, we should sketch out how exchange rate
movements affect a nation's trading relationships with
other nations. A higher currency makes a country's
exports more expensive and imports cheaper in foreign
markets; a lower currency makes a country's exports
cheaper and its imports more expensive in foreign
markets. A higher exchange rate can be expected to lower
the country's balance of trade, while a lower exchange
rate would increase it. Numerous factors determine
exchange rates, and all are related to the trading
relationship between two countries. Remember, exchange
rates are relative, and are expressed as a comparison of
the currencies of two countries. The following are some of
the principal determinants of the exchange rate between
two countries. Note that these factors are in no particular
order; like many aspects of economics, the relative
importance of these factors is subject to much debate.

Differentials in Inflation:

As a general rule, a country with a consistently lower

inflation rate exhibits a rising currency value, as its
purchasing power increases relative to other currencies.
During the last half of the twentieth century, the countries
with low inflation included Japan, Germany and
Switzerland, while the U.S. and Canada achieved low
inflation only later. Those countries with higher inflation
typically see depreciation in their currency in relation to
the currencies of their trading partners. This is also usually
accompanied by higher interest rates.

Differentials in Interest Rates:

Interest rates, inflation and exchange rates are all highly

correlated. By manipulating interest rates, central banks
exert influence over both inflation and exchange rates,
and changing interest rates impact inflation and currency
values. Higher interest rates offer lenders in an economy a
higher return relative to other countries. Therefore, higher
interest rates attract foreign capital

and cause the exchange rate to rise. The impact of higher

interest rates is mitigated, however, if inflation in the
country is much higher than in others, or if additional
factors serve to drive the currency down. The opposite
relationship exists for decreasing Inter interest rates
exchange rates. that is, lower interest rates tend to
decrease

Current-Account Deficits:

The current account is the balance of trade between a

country and its trading partners, reflecting all payments
between countries. for goods, services, interest and
dividends. A deficit in the current account shows the
country is spending more on foreign trade than it is
earning, and that it is borrowing capital from foreign
sources to make up the deficit. In other words, the country
requires more foreign currency than it receives through
sales of exports, and it supplies more of its own currency
than foreigners demand for its products. The excess
demand for foreign currency lowers the country's
exchange rate until domestic goods and services are
cheap enough for foreigners, and foreign assets are too
expensive to generate sales for domestic interests.

Public Debt:

Countries will engage in large-scale deficit financing to

pay for public sector projects and governmental funding.
While such activity stimulates the domestic economy.
Nations with large public deficits and debts are less
attractive to foreign investors. The reason? A large debt
encourages inflation, and if inflation is high, the debt will
be serviced and ultimately paid off with cheaper real
dollars in the future. In the worst case scenario, a
government may print money to pay part of a large debt,
but increasing the money supply inevitably causes
inflation. Moreover, if a government is not able to service
its deficit through domestic means (selling domestic
bonds, increasing the money supply), then it must
increase the supply of securities for sale to foreigners,
thereby lowering their prices. Finally, a large debt may
prove worrisome to foreigners if they believe the country
risks defaulting on its obligations. Foreigners will be less
willing to own securities denominated in that currency if
the risk of default is great. For this reason, the country's
debt rating (as determined by Moody's or Standard &
Poor's, for example) is a crucial determinant of its
exchange rate.

Terms of Trade:

Trade of goods and services between countries is the

major reason for the demand and supply of foreign
currencies. A ratio comparing export prices to import
prices, the terms of trade is related to current accounts
and the balance of payments. If the price of a country's
exports rises by a greater rate than that of its imports, its
terms of trade have favorable improved. Increasing terms
of trade shows greater demand for the country's exports.
This, in turn, results in rising revenues from exports, which
provides increased demand for the country's currency
(and an increase in the currency's value). If the price of
exports rises by a smaller rate than that of that of its
imports, the currency's value will decrease in relation to
its trading partners. This is a typical case for
underdeveloped countries which rely on imports for
development needs. The current account balance (deficit
or surplus) thus reflects the strength and weakness of the
domestic currency.

FUNDAMENTAL FACTORS VIZ.

POLITICAL STABILITY AND ECONOMIC
PERFORMANCE:

Fundamental factors include all such events that affect the

basic economic and fiscal policies of the concerned
government. These factors normally affect the long-term
exchange rates of any currency. On short-term basis on
many occasions, these factors are found to be rather
inactive unless the market attention has turned to
fundamentals. However, in the long run exchange rates of
all the currencies are linked to fundamental causes. The
fundamental factors are basic economic policies followed
by the government in relation to inflation, balance of
payment position, unemployment, capacity utilization,
trends in import and export, etc. Normally, other things
remaining constant the currencies of the countries that
follow the sound economic policies will always be stronger.
Similar for the countries which are having balance of
payment surplus, the exchange rate will always be
favorable. Conversely, for countries facing balance of
payment deficit, the exchange rate will be adverse.
Continuous and ever growing deficit in balance of
payment indicates over valuation of the currency
concerned and the dis-equilibrium created can be
remedied through devaluation. Foreign investors
inevitably seek out stable countries with strong economic
performance in which to invest their capital. A country
with such positive attributes will draw investment funds
away from other countries perceived to have more
political and economic risk. Political turmoil, for example,
can cause a loss of confidence in a currency and a
movement of capital to the currencies of more stable
countries.

Political and Psychological factors:

Political and psychological factors are believed to have an

influence on exchange rates. Many currencies have a
tradition of behaving in a particular way for e.g. Swiss
Franc as a refuge currency.
The US Dollar is also considered a safer haven currency
whenever there is a political crisis anywhere in the world.

Speculation:

Speculation or the anticipation of the market participants

many a times is the prime reason for exchange rate
movements. The total foreign exchange turnover
worldwide is many times the actual goods and services
related turnover indicating the grip of speculators over the
market. Those speculators anticipate the events even
before the actual data is out and position themselves.
accordingly in order to take advantage when the actual
data confirms the anticipations. The initial positioning and
final profit taking make exchange rates volatile. These
speculators many times concentrate only on one factor
affecting the exchange rate and as a result the market
psychology tends to concentrate only. on that factor
neglecting all other factors that have equal bearing on the
exchange rate movement. Under these circumstances.
even when all other factors may indicate negative impact
on the exchange rate of the currency if the one factor that
the market is concentrating comes out positive the
currency strengthens.

Capital Movement:

The phenomenon of capital movement affecting the

exchange rate has a very recent origin. Huge surplus of
petroleum exporting countries due to sudden spurt in the
oil prices could not be utilized by these countries for home
consumption entirely and needed to be invested
elsewhere productively. Movement of these Petrodollars,
started Affecting the exchange rates of various currencies.
Capital tended to move from lower yielding to higher
yielding currencies and as a result the exchange rates
moved. International investments in the form of Foreign
direct investment (FDI) and Foreign Institutional
Investments (FII) have become the most important factors
affecting the Exchange rate in today's open world
economy. Countries which attract large capital Inflows
through foreign investments, will witness an appreciation
in its domestic currency as its demand rises. Outflow of
capital would mean a depreciation of domestic currency.

Intervention:

Exchange rates are also influenced in no small measure by

expectation of changes in regulation relating to exchange
markets and official intervention. Official intervention can
smoothen an otherwise disorderly market but it is also the
experience that if the authorities attempt half-heartedly to
counter the market sentiments through intervention in the
market, ultimately more steep and sudden exchange rate
swings can occur. In the second quarter of 1985 the
movement of exchange rates of major currencies reflected
the change in the US policy in favour of coordinate
exchange market intervention as a measure to bring down
the value of dollar.

Stock Exchange Operations:

Stock exchange operations in foreign securities,
debentures, stocks and shares, influence the demand and
supply of related currencies, thus influencing their
exchange rate
.
Political Factors:

Political scenario of the country ultimately decides the

strength of the country. Stable efficient government at the
centre will encourage positive development in the country,
creating success up investor confidence and a good image
in the international market. An economy with a strong,
positive image will obviously have a strong domestic
currency. This is the reason
why speculations raise considerably during the parliament
elections, with various predictions of the future
government and its policies. In 1998, the Indian rupee
depreciated against the dollar due to the American
sanctions after India conducted the Pokhran nuclear test.

Others:

The turnover of the market is not entirely trade related

and hence the funds placed at the disposal of foreign
exchange dealers by various banks, the amount which the
dealers can raise in various ways. banks' attitude towards
keeping open position during the course of a day, at the
end of the day, on the eve of weekends and holidays
window dressing operations as at the end of the half year
to year, end of the month considerations to cover
operations for the returns that the banks have to submit
the central monetary authorities etc, all affect the
exchange rate movement of the currencies. Value of a
currency is thus not a simple result of its demand and
supply, but a complex mix of multiple factors influencing
the demand and supply. It's a tight rope walk for any
country to maintain a strong, stable currency, with policies
taking care of conflicting demands like inflation and export
promotion, welcoming foreign investments and avoiding
an appreciation of the domestic currency, all at the same
time.

2.9 SOME IMPORTANT CURRENCIES:

No doubt, all currencies are important but some of the

currencies are the ones which are traded the most around
the world. These include:

The US Dollar ($) - It is the most traded currency on the

planet and it is paired with every other major currency in
the world and often used as an intermediary in triangular
(three way) transactions. Some countries even use USD
as their official currency (termed as dollarization of their
currency). In 1991-1 USD=22.74 and currently 1 USD =
84.44 INR
The Euro (€) - It is the second most traded currency in the
world and it serves most of the surozone nations. Many
nations in Africa and Europe peg their currencies to Euro.
A key feature of this currency is that in forex market euro
adds liquidity to any currency pair which it trades.

The Japanese Yen (¥)- It is the most traded Asian

Currency and it measures the overall health of the pan
Pacific Region. In late 1999 and 2000s Japan had a very
low inflation rate leading to more and more FDIs and Flis
and traders borrowed the Japanese Yen and then invested
in other higher yielding currencies.

The British Pound (£)- It is the fourth most traded currency

in the world. Although the U.K. was an official member of
the t European Union, the country never adopted the euro
as its official currency for a variety of reasons, namely
historic pride in the pound and maintaining control of
domestic interest rates. Forex traders will often estimate
the value of the British pound based on the overall
strength of the British economy and political stability of its
government.

The Canadian Dollar (C$): Also known as Joonie, the

Canadian Dollar is probably the world's foremost
commodity currency, meaning that it often moves in step
with the commodities markets-notably crude oil, precious
metals, and minerals. With Canada being such a large
exporter of such commodities, the loonie often reacts to
movements in underlying commodities prices, especially
that of crude oil.

The Swiss Franc (₣): Last is the Swiss franc, which, much
like Switzerland, is viewed by many as a "neutral"
currency. More accurately, the Swiss franc is considered a
safe haven within the forex market, primarily due to the
fact that the franc tends to move differently than more
volatile commodity currencies, such as the Canadian and
Australian dollars.

The Swiss National Bank has actually been known to be

quite active in the forex market to ensure that the franc
trades within a relatively tight range, to reduce volatility,
and to keep interest rates in check.

3.0 FOREIGN EXCHANGE IN 1991 IN INDIA AFTER

LIBERALIZATION, GLOBALIZATION AND
PRIVATIZATION.

In 1991, India faced huge economic crises which led India

to adapt the new economic policy. The crises made India
under poor economic policies and resulted in huge trade
deficits. The value of the Indian Rupee was very low in the
foreign exchange market due to the same reason. The
economy's foreign exchange reserves had dried up and
the country was about to go into debt.
The reserves were supporlive for 3 weeks' worth of
imports. Pledging the gold reserves of a country was a
thing to do of the last resort but we had no other option. In
an attempt to seek an economic bailout from the IMF, the
Indian government airlifted its national gold reserves.

To understand more deeply the change in foreign

exchange reserves from 1991 to 2018, let us compare the
value of rupee in 1990(before liberalization), 1991(after
liberalization) and 2018 with the respective value of a U.S.
Dollar

In 1991 (therefore liberalization) the trade deficits with

the other economies like China and US and Britain were
very high. To correct the adverse Balance of Payment,
devaluation of the Indian Rupee was taken into
consideration. Devaluation means reduction in the
external value of the domestic currency while internal
value of the domestic currency remains constant.

The economic crisis of 1991 is claimed to be the toughest

time in the Indian economy.

The fiscal deficit during this time was 7.8% of the GDP
and nearly 40% of paying total revenue collected by the
government was spent on the interest on the debt. In
addition, the inflationary rate was 14% and that made the
situation even worse.
The value of the Rupee had been devalued to Rs. 24.58
per one US Dollar which at that time was a very high value
for a dollar.

India had faced a great amount to economic regression in

the years 1990-91 and had to adapt the new economic
policy as well as the foreign trade policy. The license raj
was no more. The economy was now open for all types of
foreign investments. The Gulf war also had a huge impact
as the prices of oil touched the sky. India was still
dependent on the Arab countries for Oil and it imported a
lot of Oil from there. Due to the war, India had to spend
700 crore more on oil than it usually did and the foreign
exchange reserves were about to get over in about only
seven days.
The value of the Indian Rupee was very low as it
depreciated a lot. But after the pledging of gold reserves
as well as the help given to the US Army during the Gulf
War made us eligible for borrowing money from
International Institutions such as the IMF (because US has
an 80% vote in the IMF) and other central banks from
countries like Japan,

On the other hand, In 2018, India had a very high trade

deficit but is comparatively much more stable than that in
the 1991 economic crisis. India Imports from 173 countries
in 2018 and exports in 126 counties

1972-92

With the breaking down of the Bretton Woods System,

India moved towards the pegged exchange rate system.
The Indian Rupee was linked (Pegged) to U.K. Pound
Sterling. This pegging of currency to another country's
currency results in a fixed exchange rate system. It
maintains stability among the trading. partners. However,
although a currency peg can minimize fluctuation, at the
same time it increases the imbalances between countries.
Therefore, in 1975, Rupee was pegged to a basket of
currencies. This was done to ensure the stability of Rupee
and avoid weaknesses associated with a single currency.
During 1990 and 1991, India faced a major Balance of
Payment (BoP) crisis. The Soviet Union was an important
trade partner of India in 1960s. As the Soviet Union
started to crack in the 1980s, India's exports went down
significantly. Also, due to the Gulf crisis in 1990, the prices
of crude oil (an important import for India) started
touching the skies in prices. Those are two of many
reasons that led India to the BoP crisis of 1991. As our
exports to the Soviet Union declined rapidly and the prices
of imports including Crude Oil rose sharply, India faced
huge BoP deficits- i.e. Imports were way higher than the
Exports- This led the country to near bankruptcy.
Therefore, India was forced to borrow money from the
International Monetary Fund (IMF) against the country's
gold reserves. The crisis certainly did not develop
overnight. It is believed that the roots of this crisis in India
developed during 1979-81. During that period, India
suffered a severe drought as well as the tremors of the
global oil shock caused by the Islamic revolution in Iran.
As a result of the BoP crisis, foreign exchange reserves
had fallen. to low levels that weren't enough to pay for
even a month of imports. The policymakers discussed
various ways to deal with the crisis that eventually led to
liberalization of the economy. Another way to deal with
the situation was devaluation of the rupee.Devaluation
implies to a decrease in exchange rate. This leads to an
increase in exports and hence the inflow of foreign
currency increases. Therefore, on July 1 1991, as a part of
its daily adjustments to the currency, RBI decreased the
exchange rate by 9%. Two days later, Le. on 3rd July 1991,
it was pegged down by another 11%. In an article in the
Indian Express on 10 November 2015, C. Rangarajan, the
then deputy governor of RBI, explained that this move of
was planned and well documented and the project was
code-narned 'hop, skip, and jump'. With this, the pegged
exchange rate system ended and India moved towards a
market determined exchange rate system.