Exchange rate (foreign exchange rate) is the rate at which domestic currency is traded for a foreign currency. Similarly, it is the rate that shows the value of domestic currency in terms of other currencies. Here, the value of Rupee means the value measured in terms of other currencies like the US Dollar.
Exchange rate system refers to the arrangement for the movement of exchange rate. There are basically three types of exchange rate systems globally: flexible or floating exchange rate system, fixed exchange rate system and managed floating (intermediate exchange rate system).
Managed floating or Intermediate Exchange rate System
India is having this type of exchange rate system. In this hybrid exchange rate system, the exchange rate is basically determined in the foreign exchange market through the operation of market forces. Market forces mean the selling and buying activities by various individuals and institutions. So far, the managed floating exchange rate system is similar to the flexible exchange rate system.
But during extreme fluctuations, the central bank under a managed floating exchange rate system (like the RBI) intervenes in the foreign exchange market. Objective of this intervention is to minimise the fluctuation in the exchange rate of rupee.
Since, the exchange rate is basically determined by market forces, the upward and downward movement in the value of rupee are appreciation and depreciation.
What is Depreciation?
Depreciation of the rupee refers to the decrease in the external value of the domestic currency occurred due to the operation of market forces. Here, the exchange rate is moving with demand and supply of dollar. Depreciation happens under a flexible exchange rate system or under a managed floating exchange rate system. (Eg. 1$ = Rs 40 to 1$ = Rs 50)
What is Appreciation?
Appreciation of the rupee refers to the increase in the external value of the domestic currency occurred due to the operation of market forces. Here, the exchange rate is moving in accordance with the demand and supply of dollar. Appreciation happens under a flexible exchange rate system or under a managed floating (Eg. 1$ = Rs 65 to 1$ = Rs 50).
In India, the exchange rate system is managed floating (from 1994 onwards) and hence the relevant currency movements are appreciation and depreciation. Here, the exchange rate is determined in the open market through the pressure of buying and selling of foreign currencies.
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