Rupee Sterilization

Rupee Sterilization

Subject: Economy

Section:

Context- The rupee is unlikely to be majorly impacted as the recent episodes of rupee volatility has been much less. Also the lower forex volatility in India have diminished the depreciation risks, a research report from State Bank of India (SBI) said.

Concept-

What Is Sterilization?

• Sterilization is a form of monetary action in which a central bank seeks to limit the effect of inflows and outflows of capital on the money supply.
• Classical sterilization involves central banks conducting buy and sell operations in open markets.
• Sterilization most frequently involves the purchase or sale of financial assets by a central bank and is designed to offset the effect of foreign exchange intervention.
• The sterilization process is used to manipulate the value of one domestic currency relative to another and is initiated in the foreign exchange market.

Example of Sterilization

• A U.S. investor looking to invest in India must use dollars to purchase rupees.
• If a lot of U.S. investors start buying up rupees, the rupee exchange rate will increase.
• At this point, the Indian central bank can either let the fluctuation continue, which can drive up the price of Indian exports, or it can buy foreign currency with its reserves in order to drive down the exchange rate.
• If the central bank decides to buy foreign currency, it can attempt to offset the increase of rupees in the market by selling rupee-denominated government bonds.