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Forex interventions not limiting monetary policy independence, finds RBI staff paper

The RBI's forex intervention to contain volatility of the rupee’s exchange rate against the dollar and the resultant increase in the money supply is “neither inflationary nor elicits a policy rate response, the paper showed.

September 21, 2022 / 06:29 PM IST

The Reserve Bank of India’s (RBI) exchange rate policy is not constraining its independence to determine monetary policy, according to the findings of an RBI staff paper.

“The results suggest that there is high degree of sterilisation (-0.92) of the increase in the money supply resulting from forex market interventions, but the offset coefficient of -0.56 highlights that offsetting flows due to decline in net domestic assets and hardening of yields do not constrain monetary policy independence,” the paper showed.

The paper titled ‘Monetary Policy Independence under a Flexible Exchange Rate Regime – The Indian Case,’ authored by Harpreet Singh Grewal and Pushpa Trivedi was published on the central bank’s website on September 21. Grewal is the deputy general manager, department of external investments and operations at the RBI. Trivedi is a senior professor at Shiv Nadar University Chennai and visiting professor, department of humanities and social sciences at IIT Dharwad.

The views expressed in these papers are those of the authors and not necessarily those of the institutions to which they belong.

The findings come at a time when there are calls for rate action to stem the rupee's fall against the dollar. The RBI, as a market regulator, has repeatedly stated that it will act to contain volatility in the rupee’s exchange rate against the dollar. Whenever the rupee has depreciated significantly, the RBI has intervened in the spot and forwards market by selling dollars from its forex kitty. Similarly, when the rupee appreciated, the RBI has also absorbed dollars from the market in the event of a surge in foreign inflows.

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The Indian rupee fell past 80 to a dollar for the first time this month on September 21 to a near a record low amid broad weakness in emerging Asian currencies ahead of a key interest rate decision from the Federal Reserve, Bloomberg reported. The rupee has been quite volatile of late as central banks across the world tighten monetary policy to contain inflation. The RBI-led Monetary Policy Committee’s decision is due on Sep 30, and economists expect another rate hike this month.

Typically, in such a scenario, policymakers are met with a trillemma where monetary policy independence, exchange rate stability and capital account openness cannot be achieved simultaneously. The paper found evidence of effective sterilisation of the money supply impact arising from forex market interventions, and no major constraining influence of forex market interventions on the independence of monetary policy.

The paper also acknowledged that he moderation in global risks leads to higher capital inflows into India. However, the consequent forex intervention to contain volatility of the rupee’s exchange rate against the dollar and the resultant increase in the money supply is “neither inflationary nor elicits a policy rate response,” it said.
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first published: Sep 21, 2022 06:29 pm
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