INTERNATIONAL INSTITUTE OF FOREIGN TRADE & RESEARCH

DEVALUATION

SUBMITTED TO:- SUBMITTED BY:-

Prof. Arpan Shrivastava Summy Vasu

MBA(FT) III-sem.

Chronology of India’s Exchange rate policy

• 1947(When India became member of IMF): Rupee tied to pound.• 18 September, 1949: Pound devalued; India maintained par with

pound.• 6 June, 1966: Rupee is devalued, Rs.4.76 = $1 after devaluation

Rs.7.50 = $1 (57.5%).• 18 November, 1967: UK devalued pound, India did not devalued.• August 1971: Rupee pegged to gold/dollar, International financial

crisis.• 18 December, 1971: Dollar is devalued.• 20 December, 1971: Rupee is pegged to pound sterling again.• 1971-1979: The rupee is overvalued due to India’s policy of

import substitution.

Chronology of India’s Exchange rate policy

• 23 June, 1972: UK float pound, India maintains fixed exchange rate with pound.

• 1975: India links rupee with basket of currencies of major trading partners. Although the basket was periodically altered, the link was maintained until the 1991 devaluation.

• July 1991: Rupee devalued by 18-19%.• March 1992: Dual exchange rate, LERMS, Liberalized

Exchange Rate Management System.• March 1993: Unified exchange rate: $1 = Rs.31.37• 1993/1994: Rupee is made freely convertible for trading

but not for investment purposes.

Needs for Devaluation

• Overvaluation of the currency associated with import substitution for industrialization as opposed to export promotion policies,

• The risk of losing competitiveness,• Economic stabilization,• Correcting the price distortions,• To increase competitiveness in the foreign

markets,• To raise national income per capita,

Needs for Devaluation

• Achieve higher standards of living for their population close the development gap,

• Government policies of high tariffs on imports,

• Restrictions on commodity as well as capital flows,

• A cycle of competitive devaluation.

The Effects of Devaluation

• Positive effects• Improve trade balance • Alleviate BoPs difficulties• Accordingly expand output & employment.

Results of Devaluation

• Devaluation is likely to be compressed in the short run(i.e. within the same year dev. occurs), expansionary in the medium run(the year following devaluation) & neutral in the long run, i.e. negative & positive effects offset each other overtime.

• The results appear to be valid for both manufacturing exporters & agricultural & primary exporters.

• Fiscal expansion(increasing the relative size of government expenditures) has a significant positive effects on output growth for all countries regardless of their export composition.

Results of Devaluation(Cont.)

• Similarly, unexpected monetary expansion also positively affects output growth.

• The effects of terms of trade changes on output is generally negative for agricultural & primary exporters, but fluctuating for manufacturing exporters.

• Manufacturing product exporters have a higher output growth trend than agricultural & primary exporters.

Approach to Measuring Effects of Devaluation on Output

• The control group approach which aims at separating the effects of devaluation from other factors on output.

• The before and after approach which aims at separating the effects of devaluation from others on output.

Approach to Measuring Effects of Devaluation on Output(Cont.)

• The macro-simulation approach studies changes in country performance at the time of devaluation on output.

• The econometric approach applies econometric methods to time series to investigate the effects of devaluation on output.

The 1966 Devaluation

• Current a/c deficit of over Rs. 290 crore due to SECOND five year plan(capital goods import).

• Inflation has caused Indian prices to become much higher than world prices.

• Budget deficit due to Defense spending in 1965/1966 was 24.06% of total expenditure.

• Money supply increase.• Depleting foreign reserves.

The 1966 Devaluation(Cont.)

• The first was India’s war with Pakistan in late 1965.

• The US & other countries friendly towards Pakistan withdrew foreign aid to India.

• The drought of 1965/1966.

The 1991 Devaluation

• To avert a financial crisis.• The trade deficit in 1990 was US$ 9.44

billion.• The gulf war lead to much higher imports

due to the rise in oil prices.• The current a/c deficit was US$ 9.7 billion.• Cost pull inflation.• Political & economical instablility.

The 1991 Devaluation(Cont.)

• Higher inflation rate. • Depleting foreign exchange reserves.• Gold is pedged to IMF by preceding

government.

Difference between Two Crisis

• In July 1966, India was forced by economic necessity to devalue the rupee & attempt to liberalize the economic crisis.

• While the devaluation of 1991 was economically necessary to avert a financial crisis, the radical changes in India’s economic policies were, to some extent, undertaken voluntarily by the government of P. V. Narasimha Rao.

Results for India

India has been able to improve capital reserve by positive BoP in capital a/c while still maintaining deficit in current a/c.

• It has failed to take advantage of its devaluated currency by increasing exports to world market & hence increasing the percentage share in world trade significantly.

Results for India(Cont.)

• The sectors like IT, Automobile has been the biggest gainers with a spate of new players entering Indian players to take advantage of cheaper outsourcing since early 90’s.

• Some how it has been able to improve economic prosperity in home as well credit worthiness in world.

Thank You.