ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

M RamachandranSubscribe to M Ramachandran

Appetite for Official Reserves

There is a strong nexus between the level of reserves, frequency of intervention, and exchange rate variability. Given the current exchange rate arrangements, there is a mandate to accumulate reserves in line with other developments such as import growth, growth in short-term external debt, and so on. The Reserve Bank of India seems to have no option, especially in times of capital flight, than to allow the exchange rate to absorb market pressure if the volume of reserves held is not adequate. This indicates a limited scope for using other instruments. The objective of accumulating additional reserves seems to override the ambition of exchange rate stability when there is a limit on the capacity to intervene imposed by the reserve shortfall. Therefore, reserves matter in times of crisis.

Resisting Rupee Appreciation?

In some quarters, the Reserve Bank of India has been accused of resisting rupee appreciation through active exchange rate interventions and thus worsening inflation. While liquidity explosion becomes the logical corollary of the RBI's exchange rate management, the latter does not seem to have a strict correspondence with the emergence of recent inflationary pressures. In the face of the dollar's weakness and perennial capital inflows, the RBI has accomplished a balancing act of stabilising the real effective exchange rate and not allowing the nominal exchange rate to move according to the dictates of speculative global finance.

Fiscal Deficit, RBI Autonomy and Monetary Management

Changing money supply-process, mainly in response to increasing financial market openness and growing market orientation of the financial structure, has made the monetary targeting exercise more complicated. This is made worse by the continuing automatic monetisation of fiscal deficit. Thus, fiscal correction is an inevitable precondition of RBI autonomy and the efficacy of its policy.
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