Managed Floating Exchange Rate

Introduction

In order to understand what a floating exchange rate is, one must first understand what an exchange rate means. The exchange rate of a currency is the rate of exchange of the currency against foreign currencies (usually, it is compared with US Dollars). The exchange rate regime is adopted by the Central Bank of India or the Reserve Bank. The idea of an exchange rate is to ideate, establish, and operate a functional rate of exchange against foreign currencies. This is also known as the forex rate.

Let us see first what is depreciation and appreciation of currencies in the following table.

Depreciation of currencies	Appreciation of Currencies
When the value of a currency decreases in comparison to the value of another foreign currency, the currency is said to be depreciated. This occurs due to the action of various market forces that work together in the complex web of financial markets of the world.	It is the opposite of depreciation. When the value of a currency increases in comparison to another foreign currency, the value of the currency is said to be appreciated.

The country’s exchange rate is determined depending on political, social, and fiscal conditions. There are mainly three types of exchange rate regimes −

• The free float regime

• The flexible regime

• The managed float regime.

India follows a managed floating regime wherein the market forces get enough freedom to operate on their own while the manager bank can also have control of the economy as and when required. India started following managed floating rate system in 1991.

Managed Floating Exchange Rate System

In managed floating exchange rate system, a country's currency may fluctuate up and down, but the government and the central bank may intervene to control the exchange rate. This intervention by the government and RBI is intended to stabilize the rates of currency. Moreover, there is a chance of suffering an economic shock in the country if the exchange rate is not controlled by the authorities. As the Indian economy is in the developing stage, it is crucial for the country to follow a managed floating rate system wherein it can have economic growth under a government and RBI-controlled mechanism.

It is notable that more than 40 percent of all the countries in the world follow a managed floating system. Countries that do not have a managed floating system, such as Argentina, Egypt, Romania, and Ukraine have faced increasing foreign exchange rates in the recent past.

The managed floating rate system is also known as ‘dirty float’ which is opposite to the ‘clean float’ system which does not have any controlling authority. The managed floating exchange rate system is a hybrid system; it is neither free float nor a flexible form of exchange rate mechanism.

Objectives of Managed Floating Exchange Rate Mechanism

It has been observed that countries in the developing stage that has high GDP growth rates prefer managed floating exchange rate regimes due to their susceptibility to geopolitical regimes the results of which are beyond the control of the authorities of these countries. However, the major four objectives of having a managed floating rate are the following −

To diminish or stop exchange rate volatility

The Indian rupee’s value against the USD is an important benchmark for India because the rates of essential commodities in the international market such as crude oil depend on this. Therefore, the value of Indian currency must be kept at an acceptable level to help the country from getting exchange rate shocks due to the volatility of its strength. For example, Indian Rupee’s strength became a matter of political dispute when it reached Rs 80/ Dollar. The opposition said that the government had failed to control the value of the Indian Rupee.

To have enough of forex reserves

India faced a constraining Balance of Payments (BoP) crisis in 1991 where it did not have enough foreign exchange to buy international goods. That is why the Indian economy was opened to the globe. To save it from another such crisis, it must have enough forex reserves which requires managed floating exchange rate regime. That is why India now has floating exchange rates.

Curbing speculative measures

Speculation is a corrective measure in foreign exchange markets. However, too much of speculative activities where a large volume of foreign reserve is bought or sold may impact the value of the nation’s currency in a harmful manner. Therefore, the government may have to intervene in order to save the economy from getting a speculative shock, and managed floating system work perfectly for this reason.

To build a robust forex market

Although the Indian government is trying to diminish its dependency on foreign markets for importing required goods, India still needs to import many such items. A robust forex market is, therefore, required which is sufficiently supported by a managed floating exchange rate regime.

Advantages of Floating Exchange Rate Regime

• Managed floating exchange rate regime offers a more resilient and powerful monetary policy for the country. In India, the RBI has its own Monetary Planning Committee that oversees the floating exchange rate policies. This helps the country have a better grip on the economy that expands due to the floating exchange rate regime policy.

• managed floating regime offers more autonomy to the constituents of the banking industry, managed floating regime can absorb more shocks in the exchange rate market. In India, this happened in 2008-09 when a two-layered protection system helped the country to sustain the shocks.

Disadvantages of Floating Exchange Rate Regime

• One of the major disadvantages of managed floating exchange rate regime is the intentional devaluation of the currency. As there is increasing competition among countries to lure big organizations and to build bigger business portfolios, this is often resulting in the intentional devaluation of the local currency.

• Managed floating exchange rate regime often makes the economy weaker. This happens because governments have to offer stimuli to certain sectors. In India, the Indian government often makes loss-making budgets which make the country’s economy weaker. Also, many governments in India are accused of not making counter-cyclical budgets.

Conclusion

It is important to learn about managed floating exchange rates because it is considered the best policy for developing economies. As the growth of GDP in developing countries is higher than in other markets, having a grip over the value of a currency is important. That is why we must understand what managed floating exchange rate regime is and how it works.

FAQs

Qns 1. What are the three types of exchange rate regimes?

Ans. The three types of exchange rate regimes are the free float regime, the flexible regime, and the managed float regime.

Qns 2. Which type of exchange rate policy works best for developing economies?

Ans.The managed floating exchange rate policy works best for developing economies .

Qns 3. When did India adopt the managed floating exchange rate policy?

Ans. India adopted the managed floating exchange rate policy in 1991.