Intervention in the foreign exchange market to stem sharp appreciation in currencies has costs, Reserve Bank of India Governor Duvvuri Subbarao said on Wednesday.
Buying dollars adds liquidity to the banking system, which aggravates inflation. Sterilising resultant liquidity can push up interest rates, which in turn attracts further inflows, the Reserve Bank of India governor said.
"Managing currency tensions will require a shared understanding on keeping exchange rates aligned to economic fundamentals, and an agreement that currency interventions should be resorted to not as an instrument of trade policy but only to manage disruptions to macroeconomic stability," Subbarao said.
Since the start of September, the rupee has risen by nearly 6% on the back of USD 11.7 billion in foreign fund inflows in stocks, attracted in part by the country's largest ever IPO, a USD 3.5 billion share sale by Coal India .
The Group of 20 advanced and emerging economies agreed on Saturday to move towards market-determined exchange rates and to pursue the full range of policies needed to reduce excessive external imbalances.
Ultra-low interest rates in developed markets have sent a flood of funds to higher-yielding emerging markets in search of higher returns, putting upward pressure on currencies and prompting several countries to impose capital controls.
The rupee, which hasn't gained as much as its Asian peers this year, has risen by 4.6% in 2010, helped by a record USD 24.7 billion foreign fund inflows into equities. In 2009, net equity portfolio inflows were USD 17.5 billion.
Subbarao said managing capital flows is not a problem that should be managed only by emerging market economies.
"In as much as lumpy and volatile flows are a spillover from policy choices of advanced economies, the burden of adjustment has to be shared," Subbarao said.
He also said that it is unrealistic to expect emerging market economies to carry the full burden of lifting global growth.
READ MORE ON Duvvuri Subbarao, RBI, fx, dollar, banking system, Sterilising resultant liquidity, currency tensions, rupee, risen, G20, Coal India, emerging economies
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