The Reserve Bank of India (RBI) has cautioned foreign exchange dealers about the cost of intervention when the rupee depreciates, and said such an intervention could conflict with the monetary policy stance.
Recalling the six-month period in 2018, when the rupee depreciated sharply to touch a historic low of 75 to a dollar, RBI Deputy Governor B.P. Kanungo said there was no fundamental change in the domestic or global economy during the period and that the volatility was due to a surge or ebb in capital flows, driven by perceptions and risk aversion, or appetite.
From 64 to a dollar in March 2018, the rupee depreciated to near-75 levels in October 2018, and again appreciated to 68 level, by March 2019 and has been trading almost flat since then.
Rupee liquidity
“The first line of defence is market interventions. But then, the impossible trinity comes into play: the interventions affect the rupee liquidity and may lead to a conflict with the monetary policy stance. Sterilisation carries a cost,” he said speaking at the FEDAI Annual Conference at Beijing on April 19. The speech was uploaded on the RBI’s website on Thursday.
“And sometimes, particularly when the rupee depreciates, there is a limitation to the extent of intervention, rendering intervention strategically ineffective,” he said. The RBI was not seen intervening aggressively in the foreign exchange market during the period in 2018 when the rupee fell sharply to touch a historic low of 75 a dollar.
This is probably the first occasion a central bank official has offered the rationale behind RBI’s action and stance when the currency was under pressure in 2018.
While the second line of defence in such circumstances is modulating the capital control regime, Mr. Kanungo said: “This must be a last resort though: because while the forex market conditions can quickly reverse, the control regime must have a longer lifetime, lest decision-making by economic agents is adversely affected.
