Question

Recent development in foreign exchange market in india

Answer 1

An economy is linked to the world economy through two broad channels: trade andfinance. India’s economic policy reforms of 1991 sought to globalize the hitherto relativelyclosed Indian economy by opening up both these channels. The changes in both tradeand the financial sector have been slow giving the economy time to adjust. Despiterestrictions, the trade channel between India and the rest of the world was far more openthan financial markets. Not only was the financial sector closed to international agents, theprice of capital (interest rate) or of the domestic currency (exchange rate) was not marketdetermined. The nineties saw a twin development in financial markets - prices wereallowed to be determined by the market, and the domestic financial market was integratingwith international financial markets.At the same time, India moved from a fixed to a floating exchange rate. However, theeconomy continued to have features of the closed economy and fixed exchange rateregime that had prevailed for a long period, even after rates were supposed to be marketdetermined. Capital controls continue. While current account convertibility for both inflowsand outflows by residents and non-residents was established as early as August 1994,controls continue on the ability of resident individuals and corporates to send capitalabroad. 2The objective of this paper is to analyze the structural changes that took place on theIndian foreign exchange market and to examine the extent to which authorities duringthat period managed to keep real exchange rates in line with long-run fundamentals.The analysis is based on an econometric analysis of the determinants of the Rupeeexchange rate [Patnaik and Pauly (2000)]. Empirically, the challenge here lies inmodelling the exchange rate for a time during which there were significant changes inthe foreign exchange regime as the transition from a fully fixed to a largely marketdetermined rate took place. Between 1991 and 1993 there existed a system when onlya proportion of export earnings could be converted into the domestic currency at themarket determined exchange rate. After January 1993 the exchange rate became fully‘market determined’. However, it was kept constant for a long period by the central bankintervention in the foreign exchange market.India’s exchange rate was fixed by the central bank until the
The Indian Foreign Exchange Market and... (PDF Download Available). Available from: https://www.researchgate.net/publication/234109516_The_Indian_Foreign_Exchange_Market_and_the_Equili... [accessed May 31 2018].