Why this matters now
Exchange-rate systems, rupee depreciation/appreciation and convertibility are core external-sector concepts tested in prelims and GS-3.
Exchange-rate systems
Currencies can be governed by a fixed (pegged) system, a floating (market-determined) system, or a managed float — a hybrid where the market sets the rate but the central bank intervenes to curb volatility. India follows a managed float, with the rupee mostly market-determined and the RBI smoothing sharp swings.
Appreciation and depreciation
Depreciation (rupee weakens, e.g. ₹/$ rises) makes exports cheaper but imports (and oil) costlier, fuelling imported inflation; appreciation does the reverse. (Note: devaluation/revaluation apply to fixed regimes; depreciation/appreciation to floating.) The REER gauges the rupee’s real, trade-weighted value.
RBI role and convertibility
The RBI manages volatility by buying/selling dollars from its reserves. The rupee is fully convertible on the current account (trade/services) but only partially on the capital account — full capital-account convertibility is approached cautiously to guard against destabilising flows.
UPSC angle
Know fixed vs floating vs managed float (India), depreciation vs devaluation, effects of a weaker rupee (exports up, imports/oil costlier), REER, RBI intervention, and current- vs capital-account convertibility.
Frequently asked questions
What exchange-rate system does India follow?
A managed float — the rupee is largely market-determined, with the RBI intervening to curb volatility.
What happens when the rupee depreciates?
Exports become cheaper while imports (including oil) become costlier, which can fuel imported inflation.
What is the difference between depreciation and devaluation?
Depreciation occurs in a floating system; devaluation is a deliberate reduction under a fixed-rate regime.
Is the rupee fully convertible?
It is fully convertible on the current account but only partially on the capital account.