Intervention in the foreign exchange market to stem sharp appreciation in currencies has costs, Reserve Bank of India Governor Duvvuri Subbarao said on Wednesday.
Buying dollars adds liquidity to the banking system, which aggravates inflation. Sterilising resultant liquidity can push up interest rates, which in turn attracts further inflows, he said.
“Managing currency tensions will require a shared understanding on keeping exchange rates aligned to economic fundamentals, and an agreement that currency interventions should be resorted to not as an instrument of trade policy but only to manage disruptions to macroeconomic stability.”
Since the start of September, the rupee has risen 6 per cent on the back of $11.7 billion (R5,2650 crore) FII inflow in stocks, attracted in part by Coal India’s R15,750 crore share sale — the country’s largest-ever IPO.
Ultra-low interest rates in developed markets have sent a flood of funds to higher-yielding emerging markets in search of higher returns, putting upward pressure on currencies and prompting several countries to impose capital controls.
The rupee has risen by 4.6 per cent in 2010, helped by a record $24.7 billion (R111,150 crore) foreign fund inflows into equities.
Managing capital flows is not a problem that should be managed only by emerging market economies, Subbarao said. “Though volatile flows are a spillover from policy choices of advanced economies, the burden of adjustment has to be shared.”