Forex intervention only to curb volatility, says Subbarao

RBI governor says providing guidance on monetary policy poses challenges

The Reserve Bank of India (RBI) on Thursday reiterated its intervention in the foreign exchange market to curb volatility in the rupee was largely market-determined. “We let our exchange rate be largely market-determined but intervene to smooth excess volatility and/or to prevent disruptions to macroeconomic stability,” RBI Governor D Subbarao said in a speech in London.

While the rupee has depreciated sharply since May, RBI has been cautious in using its foreign exchange reserves to stem the fall. RBI data shows in the week ended June 28, its total reserves fell by $3 billion to $285 billion. The country’s foreign exchange reserves are sufficient to cover imports for about six and a half months. Foreign exchange cover of eight to 10 months is seen as a comforting factor for the currency.

Earlier this month, it had touched an all-time low of Rs 61.22 a dollar. However, following liquidity-tightening measures by the central bank and occasional dollar sales by public sector banks, the rupee has recovered somewhat.

Subbarao said the capital account was only partly open---foreigners mostly enjoyed unfettered access to equity markets, though access to debt markets was restricted. “There are limits to the quantum of funds resident corporates and individuals can take out for investment abroad, but the limits are quite liberal,” he said.

He added because of liberalisation on the exchange rate and capital account fronts, some monetary policy independence was forfeited. “What the middle solution implies is we have to guard on all the three fronts, with relative emphasis across the three pillars shifting, according to our macroeconomic situation.”

The biggest concern stemming from the large fiscal deficit, especially from RBI’s perspective, was this added to aggregate demand and, therefore, to inflation pressures, Subbarao said. By crowding out the private sector, the fiscal deficit could also inhibit, if not impair, monetary policy transmission to the private sector. Credible fiscal consolidation was, therefore, a pre-condition for stabilising inflation and securing non-inflationary growth, he added.

Providing guidance on monetary policy posed challenges, he said. “We have started the practice of giving forward guidance on monetary policy. Because of its potential impact, we pay much more attention to the language and nuancing of the ‘forward guidance’ paragraphs than to other parts of the statement. Our experience in this regard has been quite positive. Nevertheless, we face some challenges.” He said guidance was always conditional. “The dilemma is how precisely the conditionality is to be communicated and how to ensure the market does not ignore the conditionality and interpret the guidance as an irrevocable commitment.”

“Conversely, how does the central bank ensure it does not become hostage to its guidance? Also, the more uncertain the situation, the greater the need for guidance. But also, the more uncertain the situation, the more difficult it is to give definitive guidance,” he said.