An Analytical View of

External Sector of India

1
 Balance of payments
• BOPs is a summary statement of economic
transactions of a residents of a country with
the rest of the world. It is a flow concept, as
the entries in this statement pertain to a
given period of time.

2
 A typical BOPs
Credit Debit Net Type of
balance
Trade in Goods Exports Imports Trade balance

Balance
account
Current
Trade in services Invisible Invisible Net Invisibles
and other receipts payments
transfers

Capital account
Capital Account Capital Inflows Capital Net capital
(Foreign direct outflow inflows

balance
investment and (Investment
foreign portfolio of Indians
inv, etc) abroad)

Totals Total Credits Total Debits Total balance

Errors and omissions

Change in Foreign Exchange Reserves (decrease +,
Increase –ve)

Sum = 0
Classification of Exchange Rate
Arrangements by IMF
 de jure Exchange Rate Arrangements

The description and effective dates of the de jure exchange rate

arrangements are provided by the countries to the IMF. Each member
is required to notify the IMF of the exchange arrangements it intends to
apply and to notify the Fund promptly of any changes in its exchange
arrangements. Country authorities are also requested to identify,
whenever possible, which of the existing categories of exchange rate
arrangements most closely corresponds to the de jure arrangement in
effect. Country authorities may also wish to briefly describe their
official exchange rate policy. The description includes officially
announced or estimated parameters of the exchange arrangement (e.g.,
parity, bands, weights, rate of crawl, and other indicators used to
manage the exchange rate). It also provides information on the
computation of the exchange rate.

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de facto Exchange Rate Arrangements

The name and the definition of the categories

describing the de facto exchange rate arrangements
have been modified in accordance with the revised
classification methodology, as of February 1, 2009.
Where the description of the de jure arrangement
can be empirically confirmed by the IMF staff over
at least the previous six months

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 Conventional peg
It involves the confirmation of the country authorities’ de jure exchange rate
arrangement. For this category the country formally (de jure) pegs its currency
at a fixed rate to another currency or basket of currencies, where the basket is
formed, for example, from the currencies of major trading or financial
partners and weights reflect the geographic distribution of trade, services, or
capital flows. The anchor currency or basket weights are public or notified to
the IMF. The country authorities stand ready to maintain the fixed parity
through direct intervention (i.e., via sale or purchase of foreign exchange in
the market) or indirect intervention (e.g., via exchange rate related use of
interest rate policy, imposition of foreign exchange regulations, exercise of
moral suasion that constrains foreign exchange activity, or intervention by
other public institutions). There is no commitment to irrevocably keep the
parity, but the formal arrangement must be confirmed empirically: the
exchange rate may fluctuate within narrow margins of less than ±1% around a
central rate or the maximum and minimum value of the spot market exchange
rate must remain within a narrow margin of 2% for at least six months.
 Currency Board
Classification as a currency board involves the
confirmation of the country authorities’ de jure exchange
rate arrangement. A currency board arrangement is a
monetary arrangement based on an explicit legislative
commitment to exchange domestic currency for a specified
foreign currency at a fixed exchange rate, combined with
restrictions on the issuing authority to ensure the fulfilment
of its legal obligation. This implies that domestic currency
is usually fully backed by foreign assets, eliminating
traditional central bank functions such as monetary control
and lender of-last-resort and leaving little scope for
discretionary monetary policy. Some flexibility may still be
afforded, depending on the strictness of the banking rules of
the currency board arrangement.
 Stabilized Arrangement
Classification as a entails a spot market exchange rate that
remains within a margin of 2% for six months or more (with
the exception of a specified number of outliers or step
adjustments) and is not floating. The required margin of
stability can be met either with respect to a single currency or
a basket of currencies, where the anchor currency or the
basket is ascertained or confirmed using statistical
techniques. Classification as a stabilized arrangement
requires that the statistical criteria are met and that the
exchange rate remains stable as a result of official action
(including structural market rigidities). The classification
does not imply a policy commitment on the part of the
country authorities.
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 Crawling Peg
Classification as a crawling peg involves the confirmation of
the country authorities’ de jure exchange rate arrangement.
The currency is adjusted in small amounts at a fixed rate or in
response to changes in selected quantitative indicators, such
as past inflation differentials vis-à-vis major trading partners
or differentials between the inflation target and expected
inflation in major trading partners. The rate of crawl can be
set to generate inflation-adjusted changes in the exchange rate
(backward looking) or set at a predetermined fixed rate and/or
below the projected inflation differentials (forward looking).
The rules and parameters of the arrangement are public or
notified to the IMF.

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 Floating Exchange Rate
A floating exchange rate is largely market determined, without an
ascertainable or predictable path for the rate. In particular, an exchange
rate that satisfies the statistical criteria for a stabilized or a crawl-like
arrangement will be classified as such unless it is clear that the stability
of the exchange rate is not the result of official actions. Foreign
exchange market intervention may be either direct or indirect, and such
intervention serves to moderate the rate of change and prevent undue
fluctuations in the exchange rate, but policies targeting a specific level
of the exchange rate are incompatible with floating. Indicators for
managing the rate are broadly judgmental (e.g., balance of payments
position, international reserves, parallel market developments).
Floating arrangements may exhibit more or less exchange rate
volatility, depending on the size of the shocks affecting the economy.

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 Free Floating

An exchange rate can be classified as free floating if intervention

occurs only exceptionally and aims to address disorderly market
conditions and if the authorities have provided information or data
confirming that intervention has been limited to at most three
instances in the previous six months, each lasting no more than three
business days. If the information or data required are not available to
the IMF staff, the arrangement will be classified as floating. Detailed
data on intervention or official foreign exchange transactions will not
be requested routinely from member countries, but only when other
information available to IMF staff is insufficient to resolve
uncertainties about the appropriate classification.

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 Official exchange rate
Provides information on the computation of
the exchange rate and the use of the official
exchange rate (accounting, customs valuation
purposes, foreign exchange transactions with
the government).

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Chronology of Exchange Rate Reform
Measures in India
In the post independence period, India’s exchange rate policy
has seen a shift from a par value system to a basket-peg and
further to a managed float exchange rate system. During the
period 1947 till 1971, India followed the par value system of
the exchange rate whereby the rupee’s external par value was
fixed at 4.15 grains of fine gold. The RBI maintained the par
value of the rupee within the permitted margin of ±1% using
pound sterling as the intervention currency. The devaluation
of the rupee in September 1949 and June 1966 in terms of
gold resulted in the reduction of the par value of rupee in
terms of gold to 2.88 and 1.83 grains of fine gold,
respectively. Since 1966, the exchange rate of the rupee
remained constant till 1971. (1 grain = .065 grams) 14
 Basket Arrangement
With the breakdown of the Bretton Woods System, in
December 1971, the rupee was linked with pound
sterling. Sterling being fixed in terms of US dollar
under the Smithsonian Agreement of 1971, the rupee
also remained stable against dollar. In order to
overcome the weaknesses associated with a single
currency peg and to ensure stability of the exchange
rate, the rupee, with effect from September 1975, was
pegged to a basket of currencies. The currencies
included in the basket as well as their relative weights
were kept confidential by the Reserve Bank to
discourage speculation. 15
 Background for Reform
• By the late ‘eighties and the early ‘nineties, it was
recognised that both macroeconomic policy and
structural factors had contributed to balance of
payment difficulties. The current account deficit
widened to 3.0 per cent of GDP in 1990-91 and the
foreign currency assets depleted to less than a
billion dollar by July 1991. It was against this
backdrop that India embarked on stabilisation and
structural reforms to generate
• impulses for growth.
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19
The Report of the High Level Committee on Balance of Payments
(Chairman Dr. C. Rangarajan) laid the framework for a credible
macroeconomic, structural and stabilisation programme encompassing
trade, industry, foreign investment, exchange rate and the foreign
exchange reserves. With regard to the exchange rate policy, the
committee recommended that consideration be given to (i) a realistic
exchange rate, (ii) avoiding use of exchange mechanisms for
subsidization, (iii) maintaining adequate level reserves to take care of
short-term fluctuations, (iv) continuing the process of liberalization on
current account, and (v) reinforcing effective control over capital
transactions. The key to the maintenance of a realistic and a stable
exchange rate is containing inflation through macro-economic policies
and ensuring net capital receipts of the scale not beyond the expectation.
The Committee further recommended that a decision be taken to unify
the exchange rate, as an important step towards full convertibility.

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The initiation of economic reforms saw, among other
measures, a two step downward exchange rate adjustment by
9 per cent and 11 per cent between July 1 and 3, 1991 to
counter the massive draw down in the foreign exchange
reserves, to install confidence in the investors and to improve
domestic competitiveness. The two-step adjustment of July
1991 effectively brought to a close the period of pegged
exchange rate. Following the recommendations of
Rangarajan Committee to move towards the market-
determined exchange rate, the Liberalised Exchange Rate
Management System (LERMS) was put in place in March
1992 involving dual exchange rate system in the interim
period. The dual exchange rate system was replaced by
unified exchange rate system in March 1993.
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 200
300
400
500

100
600

-300
-200
-100
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97

Exports
1997-98
1998-99
1999-00
2000-01

Imports
2001-02
2002-03
2003-04

BOT
2004-05
2005-06
2006-07
NINV
2007-08
2008-09
2009-10
CAB

2010-11
2011-12
India's External Sector Indicators (BN USD)

2012-13
2013-14
22

2014-15
2015-16
2016-17
 % change over previous year

-30.0
-20.0
-10.0
0.0
10.0
40.0
50.0
60.0

20.0
30.0
1991-92

1993-94

1995-96

1997-98

1999-00

EXg
2001-02

2003-04

IMg
2005-06
(derived from US $ values)

2007-08
Growth Rates of Exports and Imports

2009-10

2011-12

2013-14
23

2015-16
 Net Invisibles
140.0

120.0

100.0

80.0
BN US $

60.0

40.0

20.0

0.0

-20.0

24
 CAB
20

-20
Bn US $

-40

-60

-80

-100
25
 0.0
20.0
40.0
80.0
100.0
120.0

60.0
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
Net Captial Inflows: Bn USD

2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
26

2014-15
2015-16
2016-17
 10.0
20.0
30.0
50.0
60.0
70.0

40.0
80.0

0.0
1950
1953
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
Ruepee USD Exchange Rate

1995
1998
2001
2004
2007
27

2010
2013
 Appreciation/Depreciation/Absence thereof in Rupee-
USD Exchange Rate (Increase: Depreciation)
40.0
35.0
30.0
% change over previous year

25.0
20.0
15.0
10.0
5.0
0.0
1951
1954
1957
1960
1963

1969
1972
1975
1978
1981
1984
1987
1990
1993

1999
2002
2005
2008
2011
2014
1966

1996
-5.0
-10.0
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120 Exchange Rate of the Indian Rupee

100

80

60

40

20

0
1982

1988

1994

2000

2006
1970
1972
1974
1976
1978
1980

1984
1986

1990
1992

1996
1998

2002
2004

2008
2010
2012
2014
2016
SDR US Dollar Pound Sterling Japanese Yen Deutsche Mark/Euro

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