Professional Documents
Culture Documents
Exports and receipts of loans and investments are recorded as surplus items.
Imports or funds used to invest in foreign countries are recorded as deficit items.
A negative balance of payments means that more money is flowing out of the
country than coming in, and vice versa.
A BOP surplus means a nation has more funds coming in than it pays out to other
countries from trade and investments, which results in appreciation of its national
currency versus currencies of other nations.
A deficit in the balance of payments has the opposite effect: an excess of imports
over exports, a dependence on foreign investors, and an overvalued currency.
Countries experiencing a payments deficit must make up the difference by
exporting gold or Hard Currency reserves, such as the U.S. Dollar, that are accepted
currencies for settlement of international debts
Crisis of 1990-91
This crisis had its origin from the fiscal year 1979-80 onwards.
By the end of the 6th plan, Indias BoP deficit (Current account) rose to Rs.
11384 crore. It was the mid of 1980s when the BoP issue occupied the
centre position in Indias macroeconomic management policy.
The second Oil shock of 1979 was more severe and the value of the imports
of India became almost double between 1978-78 and 1981-82.
From 1980 to 1983, there was global recession and Indias exports suffered
during this time.
Apart from the external assistance, India had to meet its colossal deficit in
the current account through the withdrawal of SDR and borrowing from IMF
under the extended facility arrangement.
Crisis of 1990-91
A large part of the accumulated foreign exchange fund was used to offset
the BoP.
During the 7th plan, between 1985-86 and 1989-90, Indias trade deficit
amounted to Rs. 54, 204 Crore.
India was under a sever BoP crisis. In 1991, India found itself in her worst
payment crisis since 1947. The things became worse by the 1990-91 Gulf
war, which was accompanied by double digit inflation.
Indias credit rating got downgraded. The country was on the verge of
defaulting on its international commitments and was denied access to the
external commercial credit markets. In October 1990, a Net Outflow of NRI
deposits started and continued till 1991.
Crisis of 1990-91
Crisis of 1990-91
The only option left to fulfil its international commitments was to borrow against the
security of Indias Gold Reserves as collateral. The prime Minister of the countrys
caretaker government was Chandrashekhar and Finance Minister was Yashwant Sinha.
The immediate response of this Caretaker government was to secure an emergency
loan of $2.2 billion from the International Monetary Fund by pledging 67 tons of Indias
gold reserves as collateral.
On 21 May 1991, Rajiv Gandhi was assassinated in an election rally and this triggered
a nationwide sympathy wave securing victory of the Congress. The new Prime Minister
was P V Narsimha Rao. P V Narsimha Rao was Minister of Planning in the Rajiv Gandhi
Government and had been Deputy Chairman of the Planning Commission. He along
with Finance Minister Manmohan Singh started several reforms which are collectively
called Liberalization. This process brought the country back on the track and after
that Indias Foreign Currency reserves have never touched such a brutal low.
Crisis of 1990-91
Due to the currency devaluation the Indian Rupee fell from 17.50 per
dollar in 1991 to 45 per dollar in 1992. The Value of Rupee was
devaluated 23%.
Earlier Fixed exchange rate was followed and constant devaluations by the central bank to
promote exports raised the amount of external debt.
In the Union Budget 1992-93, a new system named LERMS was started. The LERMS was
introduced from March 1, 1992 and under this, a system of double exchange rates was
adopted. Under LERMS, the exporters could sell 60% of their foreign exchange earning to
the authorized Foreign Exchange dealers in the open market at the open market exchange
rate while the remaining 40% was to be sold compulsorily to RBI at the exchange rates
decided by RBI.
Another important feature of LERMS was that the Government was providing the foreign
exchange only for most essential imports. For less important imports, the importers had to
arrange themselves from the open market. Thus, we see that LERMS was introduced with
twin objectives of building up the Foreign Exchange Reserves and discourage imports. At
that time, the government was successful in achieving both of these objectives.
The rules of the game under the gold standard were clear and simple.
Each country set the rate at which its currency (paper or coin) could be
converted to a weight of gold. The United States, for example, declared
the dollar to be convertible to gold at a rate of $20.67/ ounce of gold (a
rate in effect until the beginning of World War 1).
Because the government of each country on the gold standard agreed to buy
or sell gold on demand to anyone at its own fixed parity rate, the value of
each individual currency in terms of gold, and therefore the fixed parities
between currencies, was set.
Under this system it was very important for a country to maintain adequate
reserves of gold to back its currencys value. The system also had the effect
of implicitly limiting the rate at which any individual country could expand its
money supply. The growth in money was limited to the rate at which
additional gold could be acquired by official authorities.
The gold standard worked adequately until the outbreak of World War 1
interrupted trade flows and the free movement of gold. This caused the main
trading nations to suspend the operation of the gold standard
In 1944, as World War II drew toward a close, the Allied Powers met at
Bretton Woods, New Hampshire, in order to create a new post-war
international monetary system.
The U.S. dollar was the main reserve currency held by central banks and
was the key to the web of exchange rate values. Unfortunately, the
United States ran persistent and growing deficits on its balance of
payments. A heavy capital outflow of dollars was required to finance
these deficits and to meet the growing demand for dollars from
investors and businesses.
The advocates of the floating rate system put forth two major arguments. One
is that the exchange rate varies automatically according to the changes in the
macroeconomic variables. As a result, there is no gap between the real
exchange rate and the nominal exchange rate.
The country does not need any adjustment, which is often required in a fixed
rate regime and so it does not have to bear the cost of adjustment. The other
argument is that this system possesses insulation properties, meaning that
the currency remains isolated from the shocks emanating from other counties.
It also means that the government can adopt an independent economic policy
without impinging upon the external sector performance.
In case of Independent Floating, the exchange rate is marketdetermined, with any foreign exchange intervention aimed at
moderating the rate of change and preventing undue fluctuations in the
exchange rate, rather than at establishing a level for it.
Pegging of Currency
Pegging involves fixed exchange rate with the result that trade payments
are stable.
Crawling Peg
Under this system, they allow the peg to change gradually over time to
catch up with changes in the market-determined rates.
Euro Market
They established a single currency, the Euro, which replaced the individual
currencies of the participating member states.
On December 31, 1998, the final fixed rates between the 11 participating
currencies and the Euro were put into place. On January 4, 1999, the Euro was
officially traded.
The 15 members of the European Union are also members of the European
Monetary System.
According to the EU, EMU is a single currency area, now known informally as the
Euro Zone, within the EU single market in which people, goods, services and
capital move without restrictions.
Euro Market