LIBERALISED EXCHANGE RATE MANAGEMENT SYSTEM

(LERMS)

PRESENTED BY:- amanpreet

ROLL NO. - 36 (IMS)

Introduction

O In view of the continuing pace of liberalization policy, the Liberalized Exchange Rate Management System (LERMS) has assumed a special significance in the arena of international financial management. 

O Already the rupee has been made fully convertible on current account.

O The main objective of the Government is to move the rupee finally into the era of full convertibility to boost exports.

LERMS..O Liberalized Exchange Rate Management System", (LERMS for

short), introduced with effect from 1.3.1992. O Under the LERMS, Exporters of goods and services and those who

are recipients of remittances from abroad could sell the bulk of their foreign exchange receipts at market determined rates.

O Similarly, those who need to import goods and services or undertake travel abroad could buy foreign exchange to meet such needs, at market determined rates from the authorized dealers, subject to their transactions being eligible under the liberalized exchange control system.

O By this scheme, partial convertibility of the rupee was introduced. 40% of the foreign exchange received on current account receipts, whether through export of goods or services alone needed to be converted at the official rate, while take remaining 60% was convertible at market determined rates.

O The imports of materials other than petroleum, oil products, fertilizers, defence and life saving drugs and equipment always had to be effected against market determined rates.

O All receipts of foreign exchange were required to be surrendered to authorized dealers as was the practice hitherto.

O The rate of exchange for the transactions was to be the free market rate quoted by authorized dealers except for 40% of the proceeds which would be based on the official rate fixed by the Reserve Bank of India.

O The authorized dealers were required to surrender 40% of their purchases of foreign exchange to the RBI at official rate. The remaining 60% could be retained by them for sale in free market for all permissible transactions.

O The Exporters were also given a choice to retain a maximum of 15% of the export earnings in foreign exchange itself, which could be utilized by them for their own personal needs.

Basic features of LERMS can be stated as follows:

O The exchange rate of the rupee will be determined purely on the basis of market forces of demand and supply.  It may, therefore, also could be described as “market determination exchange rate system”.

O All receipts whether on current or capital account and of the balance of payments and whether on government or private account will be converted entirely at the market rate of exchange.

O NRIs will be permitted to maintain the Residents Foreign Currency Account (RFCA) to which the entire foreign exchange brought in by them will be credited.  Moreover, those Indians who get receipts from abroad now can have the benefit of getting the entire foreign currency credit to them at the market rate.

O Exporters and the recipients of inward remittances are required to surrender the foreign currency received by them to the authorized dealers in foreign currency.  However, they are allowed to maintain 15% of the receipts, in foreign currency account with an authorized dealer.

 

CONT…Feature

O There is no obligation on the authorize dealers to sell any portion of their foreign currency receipts direct to the Reserve Bank as was the case so far.  They can sell the receipts in the Indian Market either to other authorized dealers or for any permissible transactions.

O Foreign currency remittances abroad are subject to the exchange control regulations, Of Course, it does not mean that the Reserve Bank of India's permission would be required in every case.

O The intervention currency of the Reserve Bank continues to be US Dollar.  It may at its discretion buy and sell US dollars from/to various authorized dealers.

Modified Liberalized Exchange Rate Management System (Modified LERMS)

O The process of liberalization continued further and it was decided to make the Rupee fully floating with effect from March 1, 1993.

O The new arrangement is called Modified Liberalized Exchange Rate Management System or Modified LERMS.

Salient features are as under:O Effective March 1, 1993, all foreign exchange transactions, receipts and

payments, both under current and capital accounts of balance of payments are being put through by authorized dealers at market determined exchange rates.

O Authorized dealers are free to retain the entire foreign exchange surrendered to them for being sold for permissible transactions and are not required to surrender to the Reserve Bank any portion of such receipts.

O Foreign exchange receipts are to be surrendered to the authorized dealers except in cases where the residents have been permitted by RBI to retain them either with the banks in India or abroad.

O Reserve Bank of India, under Section 40 of RBI Act, 1934, was obliged to buy and sell foreign exchange to the authorized dealers.

O Reserve Bank is now required to sell any authorized person at its offices/branches US Dollars for meeting foreign exchange payments at its exchange rates based on the market rate only for such purposes as are approved by the Central Government.

Advantages of the New System :-O The system seeks to ensure equilibrium between demand and supply with

respect to a fairly large subset of external transactions.

O It has facilitated removal of several trade restrictions and granted relaxation in exchange control (under current account transactions).

O It is a step towards full convertibility of current account transactions in order to achieve the full benefits of integrating the Indian economy with the world economic system.

O The incentives to exporters will be higher and more particularly to those whose exports are not highly import intensive. Exporters of agricultural products will find exports attractive.

O A large number of expatriates, who are hitherto denied any advantages on their remittances to India in line with the earnings of the exporters, are now eligible for market rate for the full amount of remittances being in the nature of capital inflows.

O This system, coupled with the exchange control relaxation in certain areas, and the abolition of travel tax is expected to make the havala route less tempting.

O In this context it needs to be remembered that smaller the gap between the average rate received by the exporters and other earners of foreign exchange and the market rate, the lesser will be the temptation to continue using illegal channels for remittances.

O In the fiscal area, customs revenue is likely to be higher, other things being the same, to the extent the valuation of imports would be based on the market exchange rate. It is, however, necessary to ensure that the tariff rates together with higher input values do not result in a sharp increase in import costs.