In the context of globalization and currency crises, a pertinent question that policy makers debate over is whether a country should choose a fixed or a flexible exchange rate, or some intermediate regime. In India, as a consequence of the balance of payments crisis that precipitated in 1991, the managed exchange rate float system was strengthened by making the rupee fully convertible in 1994 for the entire current account transactions .

The significance of choosing a given type of exchange rate system lies in understanding the mechanism by which it influences the growth of the economy. The exchange rate system should be stable in itself, should encourage exports by making them competitive and should attract greater capital inflows. One of the factors that determines the exports of a country is the exchange rate, since it is the number of units of the foreign currency that a foreigner has to ultimately pay to procure goods or services which is priced in the home currency. A boost to the exports increases the income, which eventually would increase the aggregate demand; further, a greater expectation of return on investment will draw more capital domestically/externally, labor and entrepreneurship leading to technical breakthroughs and growth. However, such a process would be time consuming, and, require concerted policy initiatives to realize the transformation to a higher path of growth and income. This brings in the question about the extent, to which the exchange rate should be permitted to depreciate or, the currency to be devalued, in order to encourage exports. This step would make the overall imports costlier and in turn increase the price of the exports, thereby making the exports less competitive in the international market. Hence, it is important that a country doesn't get caught in the vicious circle of devaluing the currency to facilitate export. According to the Marshall-Lerner condition, depreciation or devaluation of the currency is beneficial to a country only if the elasticity of exports and imports are `greater than one'.

In order to examine the trend in the movement of the exchange rate, the article takes the Nominal Effective Exchange Rate and the Real Effective Exchange Rate. Further, the effect of the increase or decrease in the index, reflecting appreciation or depreciation of the ratio of Net Trade Balance to GDP ratio, Net Invisibles to GDP ratio, Net Current Account Balance to GDP ratio, and Net Capital Account to GDP ratio have been examined. It can be observed from Table 1 & 2 and Graph 1 & 2 that since 1993-94, the rupee broadly depreciated over the years and has only contributed to widen the trade deficit.

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