The IMF has urged countries to preserve vital foreign reserves to deal with potentially worse outflows and turmoil in the future, amidst appreciation of the US dollar and depreciation of other major currencies, including the Indian rupee.
In a blog post by the First Deputy Managing Director of the IMF Gita Gopinath and the global lending body’s Chief Economist Pierre-Olivier Gourinchas, they said that in such a fragile environment, it is prudent to enhance resilience.
Although emerging market central banks have stockpiled dollar reserves in recent years, reflecting lessons learned from earlier crises, these buffers are limited and should be used prudently. Countries must preserve vital foreign reserves to deal with potentially worse outflows and turmoil in the future. Those that are able should reinstate swap lines with advanced-economy central banks, they said in a blog post.
Countries with sound economic policies in need of addressing moderate vulnerabilities should proactively avail themselves of the International Monetary Fund’s precautionary lines to meet future liquidity needs. Those with large foreign-currency debts should reduce foreign-exchange mismatches by using capital-flow management or macroprudential policies, in addition to debt management operations to smooth repayment profiles, they wrote.
Notably the dollar is at its highest level since 2000, having appreciated 22 per cent against the yen, 13 per cent against the Euro and 6 per cent against emerging market currencies since the start of this year. Such a sharp strengthening of the dollar in a matter of months has sizable macroeconomic implications for almost all countries, given the dominance of the dollar in international trade and finance, Gopinath and Gourinchas said in the blog post.
According to them, for many countries fighting to bring down inflation, the weakening of their currencies relative to the dollar has made the fight harder. On average, the estimated pass-through of a 10 per cent dollar appreciation into inflation is one percent, they said. The IMF officials said several countries are resorting to foreign exchange interventions. Total foreign reserves held by emerging markets and developing economies fell by more than 6 per cent in the first seven months of this year, they said.
Observing that the appropriate policy response to depreciation pressures requires a focus on the drivers of the exchange rate change and on signs of market disruptions, the IMF blog said that specifically, foreign exchange intervention should not substitute for warranted adjustment to macroeconomic policies. There is a role for intervening on a temporary basis when currency movements substantially raise financial stability risks and/or significantly disrupt the central bank’s ability to maintain price stability, it said.
Gopinath and Gourinchas noted that in some cases temporary foreign exchange intervention may be appropriate. This can also help prevent adverse financial amplification if a large depreciation increases financial stability risks, such as corporate defaults, due to mismatches, they wrote.
Finally, temporary intervention can also support monetary policy in the rare circumstances where a large exchange rate depreciation could de-anchor inflation expectations, and monetary policy alone cannot restore price stability, they said.
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