There has been considerable evolution in India’s exchange rate regime over the reform years. The shift has been from a nominal fix to one-way nominal movement over the nineties to two-way with low volatility implying a tightly managed exchange rate, to greater volatility and nominal movement after the global crisis.
The paper infers the exchange rate regime and the Government’s objectives from changing INR trends and volatility over the reform period, in the context of the fundamental determinants of exchange rates. Concerns to prevent appreciation given a trade deficit, large but volatile inflows, and higher Indian inflation led to reserve accumulation, a tendency for nominal depreciation, and relative constancy of the real exchange rate around the real effective exchange rate (REER) established after the double devaluation in the early nineties.
A watershed was the reversal of trend nominal depreciation in 2003. Then the beginnings of two-way movement in the managed float, even while large foreign exchange reserves were accumulated. The latter helped reduce risk perceptions and outflows in the period of the global crisis. Outflows did occur although they were quickly reversed. With less intervention, probably due to a precautionary motive to conserve reserves in a time of great uncertainty, there was much more nominal and real exchange rate volatility.
As the RBI Governor during the early reform years, and as a key member of committees that set the reform agenda even before that, Dr. Rangarajan was one of the architects of India’s exchange rate policy, as he was of many other aspects of Indian macroeconomic policy. A large part of the international praise for India’s calibrated opening and relatively smooth navigation of two major international crises must go to him. The opening of the economy was a period of great learning, for Indian macroeconomists, as key macroeconomic variables began to behave differently.
