Central bank’s currency-market intervention strategy

Central bank’s currency-market intervention strategy

Subject :Economy

Section:Banking

Context:

RBI prepared to spend $100 billion more defending rupee as the rupee has lost over 7% of its value in 2022 and weakened past the psychological level of 80 per US dollar.

Details:

• The RBI’s currency reserves have fallen by more than $60 billion from its peak of $642.450 billion in early September.
• Causes:
  • Valuation changes- due to depreciation of Euro and other foreign currency held as forex assets
  • Dollar selling intervention of RBI to balance exchange rate depreciation.
  • The RBI’s reserves of $580 billion remain the fifth largest in the world, giving the central bank confidence in its ability to prevent any sharp depreciation of the currency.

Central bank’s currency-market intervention strategy:

• The aim of the RBI’s policy is to allow the rupee to find its natural value in the market but without undue volatility or causing unnecessary panic among investors.
• The central bank ensures that there is no drastic drop in the rupee’s value.
• The RBI intervenes in the currency market to support the rupee as a weak domestic unit can increase a country’s import bill.
• There are a variety of methods by which RBI intervenes:
  • It can intervene directly in the currency market by buying and selling dollars.
    • If the RBI wishes to increase the rupee value, then it can sell dollars and when it needs to bring down rupee value, it can buy dollars.
  • The central bank can also influence the value of the rupee by way of monetary policy.
    • RBI can adjust the repo rate (the rate at which RBI lends to banks) and the liquidity ratio (the portion of money banks are required to invest in government bonds) to control rupee
  • Indirect method-RBI can direct select state-owned banks sell dollars in the spot market.
    • To sterilise the spot market dollar sales, banks converted them into forwards contracts through buy-sell swaps.
    • This helps on two counts.
• First, it protects the forex reserves.
• Second, the forward deal neutralizes the impact of spot interventions on liquidity.