What is the Exchange Rate Management?

By : Neha Dhyani

Updated : Jun 13, 2022, 16:45

The Indian currency, over the past years, has been falling in value against the dollar for several reasons. The exchange rate is a critical factor for comparing the country's competitiveness with other economies. Some other measures include the growth rates of GVA and GDP and even some high-frequency data like automobile sales.

What Are Exchange Rates & How Are They Determined?

The exchange rate is the price of a currency in relation to another. A currency's exchange rate with respect to the other represents the relative demand among the holders of the two currencies.

This demand, in turn, is dependent on the supply and demand in the economies. As every country interacts with others, it has an Exchange Rate Management system to see the movement of its currency relative to others.

The Objective of Exchange Rate Management

Currencies are bought and sold in the foreign exchange market. Buyers and sellers include commercial banks, foreign exchange brokers, students, central banks, and firms. The Exchange Rate Management system works through the efforts of the market players.

Exchange Rate Management objectives include ensuring that the economic fundamentals of the country reflect accurately through the currency's external value, reducing the volatility in exchange rates, and maintaining a sufficient level of foreign exchange reserves to handle external currency shocks.

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History of Exchange Rate Management In India

The Exchange Rate Management in India has gone through several changes ever since its independence. It has transformed from a fixed-rate regime to the current market-determined exchange rate system.

Under the liberalized Exchange Rate Management System, a dual exchange rate is fixed under which 40% of the earnings are surrendered at the official rate while the other 60% is to be converted at a market-determined exchange rate. India has two kinds of foreign exchange markets - Spot Market & Forward Market.

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Current Exchange Rate Management System

Presently, India follows a floating exchange rate system where the exchange rate of currencies depends much on the market forces. However, the RBI intervenes in the system during times of volatility by buying and selling the currencies to stabilize the rate.

RBI imposes some restrictions on the currency conversion using powers under the 1973 Foreign Exchange Regulation Act that was later changed to the Foreign Exchange Management Act in 1999. There are three exchange rate regimes in India - Fixed or Pegged, Flexible or Floating, and Managed Float.

Exchange Rate Management remains a critical function of central banks to ensure the smooth functioning of external and internal trade, while also planning for contingencies such as war, recessions, and natural disasters.

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FAQs on Exchange Rate Management

Q1. With respect to Exchange Rate Management, what are the main functions of a foreign exchange market?

The foreign exchange market serves two major functions - to facilitate currency conversions and to provide insurance against foreign exchange risks.

A vibrant and liquid forex market is essential for facilitating Exchange Rate Management to ensure the smooth functioning of global trade and the domestic economy.

Q2. Which is the biggest foreign exchange market, with regard to Exchange Rate Management?

The most liquid and the largest foreign exchange market in the world is Forex. It was valued at about $2.5 quadrillion in 2020, With regard to Exchange Rate Management.

Q3. What are the types of foreign exchange, in reference to Exchange Rate Management?

The primary types of foreign exchange systems are - Spot Market, Forward Market, and Futures Exchange, in reference to Exchange Rate Management.

Q4. How many sections does FEMA (Foreign Exchange Management Act) contain, with regard to Exchange Rate Management?

FEMA (Foreign Exchange Management Act) is much simpler than FERA (Foreign Exchange Regulation Act) and contains only 49 sections, with regard to Exchange Rate Management.