The exchange rate regimes in today’s international monetary and financial system, and the system itself, are profoundly different in conception and functioning from those envisaged at the 1944 meeting of Bretton Woods establishing the IMF and the World Bank. The conceptual foundation of that system was of fixed but adjustable exchange rates to avoid the undue volatility thought to characterize floating exchange rates and to prevent competitive depreciations, while permitting enough flexibility to adjust to fundamental disequilibrium under international supervision. Capital flows were expected to play only a limited role in financing payments imbalances and widespread use of controls would insulate the real economy from instability arising from short-term capital flows. Temporary official financing of payments imbalances, mainly through the IMF, would smooth the adjustment process and avoid undue disturbances to current accounts, trade flows, output, and employment

In the present system, exchange rates among the major currencies fluctuate in response to market forces, with significant short-run volatility and occasional large medium-run swings. International private capital flows finance substantial current account imbalances, and fluctuations in these flows appear to be either a cause of major macroeconomic disturbances or an important channel through which they are transmitted to the international system. The industrial countries have generally abandoned control and emerging market economies have gradually moved away from them.

Three features of the modern international monetary and financial environment are particularly noteworthy. First, the revolution in telecommunications and information technology has dramatically lowered transaction costs in financial markets and spurred financial innovation and the liberalization and deregulation of domestic and international financial transactions. This, in turn, has facilitated further innovation and capital market integration. As a result, capital mobility has reached levels not matched since the heyday of the to move toward increased exchange rate flexibility. gold standard obstacles to trade in assets have been dramatically reduced and capital movements are highly sensitive to risk-adjusted yield differentials and to shifts in perception of risks. Financial markets have also become globalized in the sense that the balance sheets of major financial and industrial companies around the world are increasingly interconnected through currency and capital markets. As a result, shocks to important individual markets or countries tend to have greater systemic repercussions.

Second, developing countries have been increasingly drawn into the integrating world economy, in terms of both their trade in goods and services and in financial assets. As a consequence, these countries have been able to reap many of the benefits of globalization. However, they also have become more exposed to some of its risks and dangers, notably to abrupt reversals in capital flows. At the same time, private capital flows have come to play a dominant role in emerging economies financing and adjustment.

Third, the emergence of the euro may mark the beginning of a trend toward a bi- or tri-polar currency system, away from reliance on the U.S. dollar as the system’s dominant currency. An important issue is whether the exchange rates between major currencies will continue to exhibit the wide swings and occasional misalignments that characterized the 1980s and 1990s. This is an important issue for the system as a whole because such swings have important repercussions for third countries—developing countries, in particular. For the latter, a wide variety of exchange rate arrangements will prevail with tendency to move toward increased exchange rate flexibility.

During the period 1950-1951 until mid-December 1973, India followed an exchange rate regime with Rupee linked to the Pound Sterling, except for the devaluations in 1966 and 1971. When the Pound Sterling floated on June 23, 1972, the Rupee’s link to the British units was maintained; paralleling the Pound’s depreciation and effecting a de facto devaluation.

On September 24, 1975, the Rupee’s ties to the Pound Sterling were broken. India conducted a managed float exchange regime with the Rupee’s effective rate placed on a controlled, floating basis and linked to a “basket of currencies” of India’s major trading partners.

In early 1990s, the above exchange rate regime came under severe pressures from the increase in trade deficit and net invisible deficit, which led the Reserve Bank of India (RBI) to undertake downward adjustment of Rupee in two stages on July 1 and July 3, 1991. This adjustment was followed by the introduction of the Liberalized Exchange Rate Management System (LERMS) in March 1992 and hence the adoption of, for the first time, a dual (official as well as market determined) exchange rate in India. However, such system was characterized by an implicit tax on exports resulting from the differential in the rates of surrender to export proceeds.

Subsequently, in March 1993, the LERMS was replaced by the unified exchange rate system and hence the system of market determined exchange rate was adopted. However, the RBI did not relinquish its right to intervene in the market to enable orderly control.

The exchange rate regime in India has undergone significant changes since independence and particularly during the beginning of 1990. The following provides a bird's eye view of major changes.

In the next two articles we will deal with the historical evolution/development of the Indian Foreign Exchange Market, a presentation from the Keynote Address by Dr.Y.V.Reddy, present Governor, RBI at the 3rd South Asian Assembly,at Katmandu, Nepal, on September 3, 1999. Dr. Reddy was the Dy.Governor in 1999 when the address was delivered.