Exchange rate driven by capital flows, says RBI

India’s forex reserves are borrowed and not built out of export surplus: Deputy Governor Kanungo

August 26, 2019 10:41 pm | Updated 10:58 pm IST - Mumbai

B.P. Kanungo.

B.P. Kanungo.

The exchange rate dynamics in India is driven by capital flows rather than current account balances, Reserve Bank of India Deputy Governor B.P. Kanungo said, adding that the central bank’s intervention in the foreign exchange market was aimed at curbing sudden turbulences not backed by economic fundamentals.

Speaking at the Forex Association of India Conference in Singapore on August 10, Mr. Kanungo said the Indian forex markets had been fairly stable in recent months. RBI uploaded his speech on its website on Monday.

“The Reserve Bank is mandated to maintain orderly conditions in the foreign exchange market. Its intervention in the forex market is solely directed at curbing sudden turbulences not backed by economic fundamentals,” he said.

The Indian currency has came under pressure in recent times due to a host of factors including trade tensions between the U.S. and China, and the central bank had intervened to curb volatility. “As has been said repeatedly, market operations are not intended to achieve any target exchange rate or band of rates. It must be pointed out that the exchange rate dynamics in India for more than a decade has been driven by capital flows rather than current account balances,” he said, adding that India had mostly run a current account deficit, notwithstanding a bilateral trade surplus with the U.S., marginally more than $20 billion during 2018.

The deputy governor said though long-term flows related to FDI and long-term debt had been fairly stable keeping in tandem with the economic fundamentals, the portfolio flows had their own dynamics depending as much on attractiveness of returns of Indian assets as the global factors determining their risk appetite.

“Gyrations in the forex market in these circumstances leave no option other than market intervention to restore orderliness in the market. One also needs to bear in mind that India’s forex reserves are borrowed reserves and not built out of export surplus,” he said.

“Inasmuch as it provides a bulwark against sudden flow reversals, it enhances the country’s ability to cope with the fall out and indeed, contributes to global stability as well,” Mr. Kanungo said.

On trade wars between the U.S. and China, he said there was no quick solution possible and such a situation had contributed to the global economic slowdown.

“As of now, there does not appear to be any possibility of quick resolution of the tension, nor does it seem to escalate and get out of hand rapidly in near future. Whatever may be the rational and economic logic behind the competitive protectionism through tariff barriers, it is certainly contributing to the global economic slowdown,” he said.

He further said the exit of Britain from the European Union was shrouded in uncertainty and it was recognised that a no-deal Brexit would surely be a disruptive factor.

“There are also risks emanating from geopolitical tensions in the Gulf and elsewhere that can adversely affect the sentiments,” he added.

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