Sentiments, perceptions causing exchange rate fluctuations: RBI Dy Guv BP Kanungo

“The forex market determines the exchange rate, an important macro-variable with implications for balance of payments, monetary policy, capital flows, and several other derived issues,” Kanungo said.

Reserve Bank of India, B P Kanungo, RBI exchange rate, forex market, banking news, indian express

RBI Deputy Governor B P Kanungo

Reserve Bank of India Deputy Governor B P Kanungo has said that fluctuations in the exchange rate are caused by sentiments and perceptions of a host of events, some domestic and some global.

“The forex market determines the exchange rate, an important macro-variable with implications for balance of payments, monetary policy, capital flows, and several other derived issues,” Kanungo said at the FEDAI Annual Conference in Beijing recently.

“Now, it is well known that in the long run, the exchange rate depends on economic fundamentals like inflation, interest rates, balance of payment position, etc., but in the short run there can be significant deviations in the exchange rate from the value dictated by the fundamentals.”

“Though the exchange rate can be measured in several ways such as REER, NEER with different combinations of currencies and different weighing schemes, the headline INR-USD rate drives sentiments and decisions,” he said.

“During the last one year or so, the rupee saw levels of 64 to a dollar in March 2018, depreciated to near-75 levels in October 2018 and again appreciated to 68+ levels by March 2019,” Kanungo said, adding that in this one year, there has not been any change in the fundamentals of the Indian economy, nor any dramatic change in the global conditions either.

“The cause mostly has been surge or ebb in capital flows, driven by perceptions and risk aversion or appetite. However, understanding these gyrations in the exchange rate does not provide any solace to the policy maker: there is a response necessary, lest the expectation turn to panic and bring a great deal of disorderliness in the market in its wake,” he said.

The RBI Deputy Governor said the first line of defence is market interventions. “But then the impossible trinity comes into play: the interventions affect the rupee liquidity and may lead to a conflict with the monetary policy stance. Sterilisation carries a cost. And sometimes, particularly when the rupee depreciates, there is a limitation to the extent of intervention, rendering intervention strategically ineffective,” he stated.

Story continues below this ad

“The second line of defence,” he added, “is resorting to modulating the capital control regime: diluting or strengthening restrictions depending on whether the rupee is appreciating or depreciating. This must be a last resort though: because while the forex market conditions can quickly reverse, the control regime must have a longer lifetime, lest decision making by economic agents is adversely affected.”