Devaluation of Indian Rupee: Reasons & History Since 1947
Devaluation of Indian Rupee taken place 3 times since 1947. In 1947 the exchange rate was 1 USD to 1 INR but today we have to spend 66 INR to buy a USD. Devaluation means reduction in the external value of the domestic currency while internal value of the domestic currency remains constant. A country goes for devaluation of its currency to correct its adverse Balance of Payment (BOP). If a country is experiencing an adverse Balance of Payment (BOP) situation then it has to devalue its currency so that its export gets cheaper and import became costlier.
Meaning of Exchange Rate: Exchange rate means the price of a nation’s currency in terms of another currency. The market in which the currencies of various countries are exchanged, traded or converted is called the foreign exchange market.
Exchange rate can be of three types:
1. Floating exchange rate
2. Fixed exchange rate
3. Managed exchange rate
Floating Exchange Rate: The system of exchange rate in which the value of a currency is allowed to adjust freely or to float as determined by demand for and supply of foreign exchange.
Fixed Exchange Rate: If the exchange rate is being determined by the government not by the demand and supply forces, it is called fixed exchange rate.
Managed Exchange Rate: In this kind of system exchange rate is partially allowed to fluctuate, government don’t allows fluctuation more than 1 to 3 percent. So in this system exchange rate is neither fixed nor free.
Par Value System: Under this system (1947-1971), each member of IMF undertook to maintain the par value of its currency in terms of gold or the U.S. dollar.
After gaining independence, India followed the par value system of the IMF. On 15th August 1947 the exchange rate between Indian rupee and US Dollar was equal to one (i.e., 1 $= 1 Indian Rupee).
In terms of currencies, the exchange rate was pegged to pound sterling at Rs. 13.33 or Rs. 4.75/dollar in Sept. 1949. This was remained unchanged till June 1966, when the rupee was devalued by 36.5% to Rs. 21/pound or 1$ = Rs. 7.10. This system continued till the 1971, when the Bretton woods system collapsed with the suspension of convertibility of the dollar by the USA.
Why value of Indian currency declined against US dollar:
At the time of independence, there were no outside loans on the balance sheet of India. But when British departed from India, Indian economy paralyzed in the absence of capital formation and proper planning.
1. Lack of Fund in the hands of the Government: In the situation of wealth crunch, Prime Minister Nehru adopted model of five year plans from Russia. Between1950s to 1960s, Indian government continuously borrowed foreign money in the form of loan. Now the exchange rate became 1$= Rs.4.75
2. War with China and Pakistan: Indian government was facing budget deficit and was in a state that it could not borrow more additional loan from outside due to negative rate of savings. India- China war of 1962, Indo-Pakistan war of 1965 and huge drought in 1966, crippled the production capacity of the Indian economy so inflation increased in the economy.
To increase the domestic production scenario, Indian government needed technology , to have technology and to tackle higher inflation and to open the Indian economy for foreign trade, government devalued external value of rupee and now
exchange rate became 1 $- Rs. 7.
3. Political Instability and Oil Shock of 1973: Oil shock of 1973 caused when the Organization of Arab Petroleum Exporting Countries (OAPEC) decided to cut the crude oil production which further increased the oil import bill. So to pay this import bill India borrowed foreign currency which reduced the value of Indian currency. Assassination of P.M. Indira Gandhi also reduced the confidence of foreigners in the Indian economy. Hence all these cases bring the exchange rate at USD = 12.34 INR in 1985 and in the 1990 it became to 1 USD = 17.50 INR.
4. Economic Crisis of 1991: It is claimed as the toughest time for Indian economy. During this phase fiscal deficit was 7.8 % of GDP, interest payment was eating 39% of the total revenue collection of the government, Current Account Deficit (CAD)was 3.69% of GDP and WPI inflation was hovering around 14%, India was about to be declared defaulter by the international community. So to tackle all these problems government devalued Indian currency again and the exchange rate became 1 USD = 24.58 INR
5. Other Reasons: Experts are saying that the value of Indian rupee has not depreciated but in fact the value of Dollar has appreciated due to expectations against US that US Federal Bank might increase the interest rates. Other reason includes...
• Inelastic import bill of petroleum products
• Import of gold in huge quantity
• Import of luxury goods
• Nuclear test: Pokhran-II
• Asian financial crisis of 1997
• Global Financial slowdown of 2007–08
• European sovereign-debt crisis (2011)
All these factors caused that the value of Indian currency is hovering around 1USD= 66 INR in 2016. The exchange rate of Rs. vs USD since 1947 till 2015 is given in the table below:
Indian currency history tells that devaluation of Indian Rupee helped Indian economy in every crisis. Devaluation of currency makes export cheaper and import costlier which ultimately improves the Balance of Payment of the domestic country.