MUMBAI: The benefits of intervening in the foreign exchange market for emerging market economies like India far outweigh the costs, according to an article published in RBI’s Jan bulletin.
The authors highlight that RBI’s interventions, both in the spot and forward markets, have effectively countered the volatility of capital flows. The report finds evidence of “symmetric effects of purchases and sales” and notes that interventions follow a “leaning against the wind” strategy, wherein the central bank steps in to moderate large swings in the currency.
The report, authored by Michael Patra, who retired this week, along with Sunil Kumar, Joice John, and Amarendra Acharya, highlights that foreign exchange intervention is a critical policy tool to manage volatility and prevent contagion risks. The authors argue, “Modern currency crises often arise from central bank balance sheet vulnerabilities rather than economic fundamentals.”
The publication comes at a time when RBI’s forex reserves have dipped significantly from a peak of $705 billion in Sept-end to $625 billion on Jan 10. A large part of the decline has been due to dollar sales by RBI to stem volatility while a part is also because of revaluation of non-dollar assets as the greenback appreciated globally.
The report outlines the motives behind foreign exchange interventions in emerging economies, which differ significantly from those in advanced economies. Unlike advanced economies, which have largely ceased interventions, emerging economies intervene regularly to stabilise markets.
“For emerging market economies, foreign exchange interventions are umbilically linked to the objective of mitigating volatility – not the level of the exchange rate,” the authors note.
