This section discusses the evolution of the rupee along with the two major currency crises that were to confront the currency and related monetary policies. History and evolution
The word “rupee” comes from the Sanskrit word “raupya” meaning Silver and traces its roots to the silver standard currency basket of the colonial rule. Originally produced in India in the 15th and 16th centuries by Mogul rulers, the currency shifted to Gold Standards in 1898 with the British dominance of the subcontinent. The currency is controlled by the Reserve Bank of India that manages the policies through its broader mandate as the acting central bank of India. Historically, the currency has been pegged to the British sterling and then to the US Dollar until 1971. As is typical of a small economy, post-independence from the British in 1947, the Indian rupee continued to be pegged to the Sterling until it faced its first major windfall in 1966 when it was devalued and pegged to the US Dollar. This lasted until the devaluation of the Dollar in 1971 upon which the rupee was re-pegged to the Sterling. In 1972, when the British Government floated the Sterling, India decided to peg it currency to a basket of currencies used by its trading partners. Although the levels of rates were altered in this basket, essentially the government held a tight control over the fixed rate. This link was maintained until the 1991 crisis during which major policy reforms brought about a floated rupee. Currency and Crises
Foreign exchange reserves are an important tool for a small and growing economy to enable trade and commerce and typically governments are sensitive of its foreign exchange reserves and of market causes that can lead to a reduction or heavy burden on its reserves. Preventive measures come in two forms: protectionist policies and tight monetary controls. The former is heavy legislation around imports and trade while the latter is tight control over the value of its currency in international markets to reduce exchange rate volatility.
Devaluation of the rupee - 1966
As a growing economy India imports more than it exports and having a fixed exchange rate typically leads to massive deficits in balance of payments. Since attaining sovereignty as a republic, despite government attempts to attain a positive balance, India ran a consistent series of deficits in its payments of debt. This would lead to a massive downward pressure on the Indian rupee in international markets that would ultimately force the government into devaluation mode in 1966. The build-up to this crisis came in a two-fold approach. Inflation had caused Indian goods to be much more expensive than international goods in the global market. This was leading to reduced exports and downward pressure on the currency rates. Further, since the 1950’s the Indian government had been running trade deficits that were causing a drain in the country’s foreign exchange reserves. Owing to the deficit, the government could not access lending from foreign shores and the private sector was shut out as it had a negative savings rate (this is typically true of any growing economy). Thus the Reserve Bank of India (“RBI”) resorted to stimulating the money supply that had an inflationary effect on the economy. The war with Pakistan in 1965 - 1966 and the great famine of 1966 led to defence being the largest expenditure of the 60’s and 70’s and the need to address the drought, precedent over any economic policy concerns. India had had foreign aid since the 1950’s but impending restrictions on trade and a significant overvaluation of its currency finally forced foreign aid to be contingent on liberalisation and devaluation. The factors mentioned above were putting a great amount of pressure on the balance of payments deficit. This finally led to the rupee being devalued in 1966 from INR 7.50 = $1 to INR 4.76 = $1 reflecting a c. 57% change and a...