The Reserve Bank of India (RBI) will continue to intervene in the currency market, as volatility in exchange rate can impact some of the country’s institutions, which might not be as robust as those in developed markets.
“There is a school of thought that says: Let the exchange rate move wherever it will,” RBI governor Raghuram Rajan said at the Inaugural Kotak Family Distinguished Lecture held at Columbia Law School in New York.
“That’s something we could do,” Rajan said. “But in emerging markets, with institutions not as strong as industrialised countries, you find there are collateral effects of both the capital moving in and going out.”
To prevent such collateral damage, the central bank will intervene in the currency market when there is a sustainable risk in global markets and the country sees a flood of capital coming in, he said.
The exchange value should reflect the country’s underlying fundamentals of trade and services.
“We really don’t want the currency to move only as result of capital flows... We would like it to be more focused on the underlying fundamentals of trade and services.”
However, the banking regulator never prevents the currency from finding its own value, but it benefits from the volatility by accumulating reserves, Rajan said. “We let the exchange rate move. We never stand in the way, but we pick up some as flows come in.”
India’s foreign exchange reserve stood at $359.9 billion as on April 8 as RBI picked up foreign exchange in the process of intervention. The RBI governor had recently said the inflation targeting framework pursued by the central bank would ensure “volatility in the currency would be a thing of the past”. Since the currency level is determined by inflation differential between two countries, predictable inflation path in a fund-recipient country eliminates the chance of volatility and thus attracts capital.
In addition, the central bank said in its monetary policy on April 5 that it would first prefer to buy foreign currency assets to manage liquidity. Rajan reiterated that the central bank was still in an accommodative monetary policy stance. RBI has so far reduced its policy rates by 150 basis points (bps), latest by 25 bps on April 5.
“As evidence of inflation and monsoon build one way or the other, this will give us more information about the direction of monetary policy,” said Rajan.
Business Standard New Delhi,20th April 2016
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