The Hindu Business Line : Forex interventions successful: RBI report

‘As the Asian crisis demonstrated, even large corporates may not be in a position to withstand sudden volatility in exchange rates and interest rates as weaknesses in corporate balance sheets can spread to other participants in the economy, including the banking sector.’

Our Bureau

Mumbai, Aug 30 The Reserve Bank of India made net market purchases of $26.8 billion from the foreign exchange market in 2006-07, significantly higher than $8.1 billion in the previous year.

The central bank’s intervention in February 2007 alone touched $11.9 billion.

The rupee appreciated by 2.3 per cent in 2006-07 and ended the year at 43.60 against the dollar.

The RBI’s annual report for 2006-07 said that the interventions in the foreign exchange market in India have been “by and large successful” in reducing volatility in the foreign exchange market.

Threat to stability

The bank has cautioned that excess volatility in the foreign exchange market is a threat to financial stability.

“While large corporates may be in a position to manage increased volatility, a large section of the population in countries like India does not have the wherewithal to withstand volatility in the financial markets,” it said.

“As the Asian crisis demonstrated, even large corporates may not be in a position to withstand sudden volatility in exchange rates and interest rates as weaknesses in corporate balance sheets can spread to other participants in the economy, including the banking sector.”

The RBI acknowledged that growing investor interest in emerging market economies along with foreign exchange convertibility restrictions have led to the development of an offshore foreign exchange market called the Non-Deliverable Forward (NDF) market in several emerging market currencies.

NDFs are types of derivatives for trading in non-convertible or restricted currencies where the delivery is in dollars.

NDF volumes have reportedly grown substantially in the past three years.

The RBI has said that while the volumes have not been large enough to affect the domestic onshore market under regular market conditions, in volatile market conditions they may impact the domestic spot market.

According to it, the enduring strength of foreign exchange inflows complicates the conduct of monetary policy.

The RBI said that in the event of demand pressures building up, increases in interest rates could be advocated to sustain growth in a non-inflationary manner.

It has also cautioned that higher interest rates would increase the possibility of further capital inflows and potentially reduce the efficacy of monetary policy tightening.

“There is evidence of some cyclical elements in the current growth process, although significant structural changes have also taken place in the Indian economy.”