Flexible (Floating) Exchange Rate. Flexible exchange rate is the rate which is determined by forces of supply and demand in the foreign exchange market. There is no official (govt.) intervention. Here the value of a currency is left completely free to be determined by market forces of demand and supply of the currencies concerned. Under this system, the central banks, without intervention, allow the exchange rate to adjust so as to equate the supply and demand for foreign currency. In India it is flexible exchange rate which is being determined. Merits and demerits of this system are listed below:
Merits. (i) Deficit or surplus in BOP is automatically corrected, (ii) There is no need for government to hold any foreign reserve, (iii) It helps in optimum resource allocation, (iv) It frees the government from problem of balance of payment, (v) Such rates are helpful in removing the barriers to trade and capital movements, (vi) Flexible exchange rate increases the efficiency in the economy by achieving best allocation of resources.
Demerits, (i) It encourages speculation leading to fluctuations in exchange rate, (ii) Wide fluctuations in exchange rate can hamper foreign trade and capital movement between countries, (iii) It generates inflationary pressure when prices of imports go up due to depreciation of currency caused by deficit in BOP. (iv) It discourages investment and international trade.
