In India, the exchange rate regime up to 1990 is best described as an adjustable nominal peg to a basket of currencies of major trading owners with a band. After the balance of payment crisis of 1991, a two-step downward adjustment in the exchange rate was undertaken and then followed by a transitional period of dual exchange rates before a market-determined exchange rate system was set in place in 1993. Since then, the exchange rate is largely determined by demand and supply conditions in the market.
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The exchange rate policy in recent years has been guided by the broad principles of careful monitoring and management of exchange rates with flexibility, without a fixed target or a pre-announced target or a band, while allowing the underlying demand and supply conditions to determine the exchange rate movements over a period in an orderly way.
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Subject to this predominant objective, the exchange rate policy is guided by the need to reduce excess volatility, prevent the emergence of destabilising speculative activities, help maintain adequate level of reserves, and develop an orderly foreign exchange market.
The Indian market, like other developing countries markets, is not yet very deep and broad, and can sometimes be characterised by uneven flow of demand and supply over different periods. In this situation, the Reserve Bank of India makes sales and purchases of foreign currency in order to even out lumpy demand and supply in the relatively thin forex market and to smoothen jerky movements.
However, such intervention is not governed by a predetermined target or band around the exchange rate. As the foreign exchange exposure of the Indian economy expands, the role of such uneven demands can be seen to reduce.