Forex interventions effectively countered capital flows volatility, says RBI study

Foreign exchange interventions by the central bank effectively countered capital flows volatility -- the main source of exchange rate volatility in India, a study published in the Reserve Bank's latest Bulletin said.

The study titled 'Foreign Exchange Intervention: Efficacy and Trade-offs in the Indian Experience', investigates the effectiveness of forex interventions undertaken by the Reserve Bank of India (RBI).

The study finds that the volatility of portfolio flows, induced by global spillovers, is the main source of exchange rate volatility in India.

"Foreign exchange interventions, both spot and forward, effectively counter capital flows volatility, with symmetric effects of purchases and sales," said the study by a team led by Michael Patra, who demitted the office of RBI Deputy Governor earlier this month.

The impact of gross spot intervention on exchange rate volatility indicates the existence of threshold effects, explaining the "leaning against the wind" phenomenon, it added.

The central bank said the views expressed in the Bulletin article are of the authors and do not represent the views of the Reserve Bank of India.

The size of the forex market has increased substantially over the years.

The study said the RBI's intervention in the foreign exchange market has been two-sided, driven by the objectives of smoothing excessive volatility, irrespective of its source.

"It is observed that demand and supply conditions witness abrupt swings because of sudden and excessive movements in foreign portfolio investment (FPI). This is corroborated by a strong co-movement between FPI flows and the RBI’s interventions," the article said.

Episodes of heightened volatility have been observed during the global financial crisis of 2008-09, the taper tantrums of 2013, the (ILFS) crisis of 2018, then COVID-19 pandemic, the Russia-Ukraine conflict and more recently, from early 2022 to late 2023, due to spillovers from synchronised monetary tightening around the world, the banking crisis of March 2023, the unwinding of yen-carry trade in August 2024 and fears of recession in September 2024.

In the second half of 2024, judicious interventions have ensured that the Indian Rupee (INR) has experienced less volatility than other major currencies, despite the unrelenting pressure from a surging US dollar and sustained outward flights of FPIs.

India's forex reserves dropped by $8.714 billion to $625.871 billion in the week ended January 10.

Earlier, the overall kitty dropped by $5.693 billion to $634.585 billion in the week ended January 3, the Reserve Bank of India said.

The reserves have been on a declining trend for the last few weeks, and the drop has been attributed to revaluation along with forex market interventions by the RBI to help reduce volatilities in the rupee. The forex reserves had increased to an all-time high of $704.885 billion in end-September.

For the week ended January 10, foreign currency assets, a major component of the reserves, decreased by $9.469 billion to $536.011 billion, the data released on Friday showed.