Foreign Exchange Intervention
Foreign exchange intervention is a monetary policy tool that involves a central bank buying or selling foreign currency to influence the exchange rate of its own currency. It’s also known as currency intervention or currency manipulation.
- How it works
- The central bank uses its own reserves or authority to generate currency
- The central bank buys or sells foreign currency in the foreign exchange market
- The goal is to influence the exchange rate and trade policy
- Why it’s done
- To stabilize the exchange rate when the domestic currency appreciates or depreciates
- To influence the monetary funds transfer rate of the national currency
- Other foreign exchange controls
- Restricting the amount of currency that can be imported or exported
- Banning the use of foreign currency within the country
- Banning locals from possessing foreign currency
- Restricting currency exchange to government-approved exchangers
- Setting fixed exchange rates
Key Findings of the Report
- Forex Interventions
- Spot and forward interventions effectively reduce capital flow volatility.
- Threshold Effects
- Moderate-scale interventions are more effective in reducing the volatility of exchange rates than large-scale interventions.
- Global Spillovers
- The main driver of exchange rate volatility in India is portfolio flows triggered by global risk sentiment.
Implications for Exchange Rate Policy
- Foreign exchange interventions are an important tool to counterbalance volatility from international capital flows.
- Exchange rate policy should concentrate on smoothing volatility rather than regulating the level of exchange rates by means of large-scale interventions.
Effect on Indian Economy
- Historical evidence shows that exchange rate volatility has destabilized real economic activity in India.
- Gradual liberalization of India’s current and capital transactions has led to more exchange rate fluctuations.
Macroeconomic Policy Framework
- Inflation targeting strengthened India’s macroeconomic policy framework, where foreign exchange interventions were merged together to result in more stability for emerging market economies.
