Tale of 2 Years: Devaluation of the Rupee
Devaluation of the Rupee: Tale of two years – 1966 and 1991
Since its Independence in 1947, India has faced two major financial crises and two consequent devaluations of the rupee. They were in 1966 and 1991.
Foreign exchange reserves are very important for any country to engage in International commerce. Having huge sums of reserves helps trade with other nations and also reduces the transaction costs associated with international commerce. When a nation runs out of foreign currency and finds that other nations are not willing to accept the nation’s currency, the only option left is to borrow abroad. But, borrowing in foreign currency means we need to pay back in the same currency or in some other hard currency. If the borrowing nation is not credit worthy to borrow from a private bank or from institutions as the IMF, then the nation has no way of paying for its imports and a financial crisis accompanied with devaluation and capital flight occurs.
The destabilizing effects of a financial crisis are so great that any country will face strong pressure from internal political forces to avoid such a crisis, even if the policies adopted come at a large economic cost. To avert a financial crisis, a nation will typically adopt policies to maintain a stable exchange rate to lessen exchange rate risk and increase international confidence. The restrictions that a country will put in place come in two forms: trade barriers and financial restrictions. Trade barriers are the restrictions on the import of certain goods and financial restrictions are on the flow of money or financial assets across international boundaries. When the flow of goods, services, and financial capital is regulated tightly enough, the government or central bank becomes strong enough, at least in theory, to dictate the exchange rate.
However, despite these policies, if the market for a nation’s currency is too weak to justify the given Exchange rate, that nation will be forced to devalue its
Since its Independence in 1947, India has faced two major financial crises and two consequent devaluations of the rupee. They were in 1966 and 1991.
Foreign exchange reserves are very important for any country to engage in International commerce. Having huge sums of reserves helps trade with other nations and also reduces the transaction costs associated with international commerce. When a nation runs out of foreign currency and finds that other nations are not willing to accept the nation’s currency, the only option left is to borrow abroad. But, borrowing in foreign currency means we need to pay back in the same currency or in some other hard currency. If the borrowing nation is not credit worthy to borrow from a private bank or from institutions as the IMF, then the nation has no way of paying for its imports and a financial crisis accompanied with devaluation and capital flight occurs.
The destabilizing effects of a financial crisis are so great that any country will face strong pressure from internal political forces to avoid such a crisis, even if the policies adopted come at a large economic cost. To avert a financial crisis, a nation will typically adopt policies to maintain a stable exchange rate to lessen exchange rate risk and increase international confidence. The restrictions that a country will put in place come in two forms: trade barriers and financial restrictions. Trade barriers are the restrictions on the import of certain goods and financial restrictions are on the flow of money or financial assets across international boundaries. When the flow of goods, services, and financial capital is regulated tightly enough, the government or central bank becomes strong enough, at least in theory, to dictate the exchange rate.
However, despite these policies, if the market for a nation’s currency is too weak to justify the given Exchange rate, that nation will be forced to devalue its