Exchange Rate Interventions

In today's Business Standard , Arvind Subramanian, Josh Felman, and I discuss the implications of a significant shift in Reserve Bank of India (RBI)'s exchange rate policy. Although not formally announced, the RBI has effectively pegged the rupee to the dollar since late 2022. Maintaining this peg has come at a steep cost—approximately $200 billion in forex interventions over two and a half years, including $100 billion since September through spot and forward markets. Such a strategy, however, is not without risks. Exchange rate pegs tend to erode competitiveness and bind monetary policy to defending the currency rather than addressing domestic economic priorities. These vulnerabilities leave the rupee exposed. Should markets perceive it as overvalued or anticipate a shift in monetary focus, speculative pressures could mount, forcing a disruptive adjustment. The prudent course for the RBI is to allow a gradual depreciation of the rupee, bringing it closer to equilibrium value. This would free monetary policy to focus on pressing domestic needs while safeguarding India's hard-earned reputation for prudent macroeconomic management. Link to the article: https://lnkd.in/gU-uyqzR

📈 USDVND rate is tightening, what's driving this trend and what's next? 🌐 USDVND rate is at 25,600 VND/USD, VND devalued -3.4% YTD. In the whole 2023, VND devalued -4.2% 💡 The primary reason for recent VND devaluation is interest rates. VND interest rates are at historic lows, even lower than the rates observed during the COVID-19 period. The gap between USD and VND interbank interest rates have remained positive since the start of 2023. Such low interest rates diminish the attractiveness of holding VND, thereby increasing the demand for USD. Recent factors including disparities in gold prices and heightened imports, have added to the pressure on VND. 🗺 When it comes to managing exchange rate volatility, there are typically two options: selling USD reserves or increasing VND interest rates. The experiences in Q3 2022 have underscored the limitations of selling USD reserves, as it often proves unsustainable and can deplete reserves rapidly. Therefore, the focus shifts to the second option: increasing interest rates.⚓ 🏛 To this end, SBV recently reintroduced Treasury bills, aiming to absorb excess liquidity from the banking system. The objective is clear: reduce liquidity to drive up VND interest rates and enhance the attractiveness of the currency, thereby stabilizing the exchange rate. This tactic mirrors actions taken in September 2023, when the State Bank issued 360 trillion VND worth of Treasury bills over seven consecutive weeks, effectively managing exchange rate fluctuations. 🤵 Industry insiders have predicted the need for interest rate interventions to stabilize the exchange rate. Indeed, Treasury bond yields and secondary market bond yields have both risen in recent weeks. 📊 However, the current scenario differs from that of September 2023. Economic growth was slow in 2023, the demand for imported goods decreased, leading to an increase in the trade surplus and a greater supply of USD. Looking ahead to 2024, an uptick in economic and consumption activities may reverse this trend, leading to increased import demand and a reduced trade surplus. Consequently, relying solely on interbank market instruments may prove insufficient. 💰 In such circumstances, it becomes imperative to increase savings interest rates, as was done in the third quarter of 2022. Despite the prevailing trend of lowering interest rates to stimulate growth, prioritizing exchange rate stability leaves little room for alternatives. 1️⃣ First and foremost, stabilizing the exchange rate must take precedence. 2️⃣ Secondly, it's crucial to note that increasing savings interest rates does not necessarily translate to an increase in lending interest rates. Supporting growth hinges on maintaining competitive lending rates. 📈 Given the evolving landscape, it wouldn't be surprising to witness an increase in VND savings interest rates in the coming months, potentially leading to a decrease in the net interest margin (NIM) of banks. 🏢

The key findings include: Despite multiple pledges over several years to introduce more market influence to the currency, the PBOC has continued intervening in the foreign exchange market on a regular basis. There has been more volatility in the exchange rate’s movement over time but little change in the underlying regime. The limited movement of the currency over the past twenty years has generally prevented the PBOC from using the exchange rate as an instrument to drive macroeconomic adjustments in China’s economy. Even when offered favorable macroeconomic conditions to change the exchange rate regime, the central bank and political leadership treaded cautiously, and made minimal progress in reform. The loss of policy credibility over the past twenty years has been severe. If the PBOC announced that they were floating the currency in July 2005, most market participants would have believed them. If the central bank made that same announcement today, virtually no one would believe it, given the persistence of intervention in the foreign exchange market over a long period of time. The current period of US dollar weakness offers a new opportunity for China to introduce new exchange rate reform….

“Stabilising the Kwacha: Zambia's Strategic Economic Maneuvers in 2024" In the early months of 2024, Zambia's financial landscape faced a significant challenge as the Kwacha experienced a marked depreciation, reaching K27.45 against the US Dollar by February. This development necessitated prompt and strategic action from the nation's economic guardians to mitigate potential repercussions. The stability of the Kwacha is not merely a point of national pride but a critical component of Zambia's economic well-being, impacting everything from import costs to foreign debt servicing. The currency's downturn can be attributed to several factors, including protracted debt restructuring talks, diminished output from the mining sector, and a surge in demand for foreign currency for essential imports such as fuel and agricultural supplies. These issues underscore the vulnerabilities in Zambia's economy, which relies heavily on mining exports and is sensitive to external financial disturbances. In response, the Bank of Zambia implemented a series of monetary policy measures aimed at stabilising the situation. This included an increase in the statutory reserve ratio, designed to tighten liquidity and aid in managing inflationary pressures. Furthermore, the policy rate was elevated to discourage excessive borrowing and spending, thereby supporting the Kwacha by mitigating inflationary pressures. Additionally, the central bank took steps to inject US dollars into the market, addressing the immediate need for foreign currency and providing temporary relief to the Kwacha. Efforts were also intensified to attract investments into the mining sector, with the objective of enhancing export earnings and bolstering foreign exchange reserves. While these interventions have yielded some positive outcomes, they are widely regarded as short-term remedies. There is a consensus that for sustained stability, Zambia needs to focus on increasing dollar inflows by enhancing export earnings, particularly from the mining sector, which plays a significant role in the country's foreign exchange reserves. The urgency of concluding extended debt restructuring negotiations is paramount, as a successful resolution would alleviate some of the pressure on the Kwacha by improving dollar liquidity. However, relying solely on monetary policy interventions may not suffice to navigate the current economic challenges. A comprehensive approach, including economic reforms and diversification of the export base beyond mining, is essential. As Zambia navigates through this period of economic uncertainty, a combination of immediate monetary measures and long-term strategic planning is crucial. The aim is not only to achieve currency stability but also to establish a resilient and diversified economy capable of sustaining growth and weathering global economic fluctuations.

Milei Intervenes in Currency Market Despite Letting Argentine Peso Float After pledging a free-floating currency a month ago, Argentina’s government has intervened in the market to influence the peso’s value, a move that stands in sharp contrast to its commitments to the International Monetary Fund. The central bank Friday confirmed it sold $409 million in futures contracts on April 30 — nearly 14% of total open interest reported that day on the local A3 futures market — confirming what many investors had been suspecting for weeks. Looking to stabilize the market, the central bank lowered implied rates and facilitated cheaper Treasury financings ahead of key debt auctions. Consulting firms believe that the intervention in April wasn’t a one-time off, but intensified the following month, especially on May 7, when the spot peso strengthened nearly 6%. That day, futures sales surged to historic highs, marking the largest increase in open interest since President Javier Milei took office. “The dynamics observed in May suggest that an escalation of this intervention was the main driver behind the consistent decline in the exchange rate during the month,” Gabriel Caamaño, an economist at Outlier Economy & Finance, wrote in a recent note to clients. The research firm estimates the central bank’s current short position is close to $1 billion, potentially even higher. It remains unclear whether the intervention raised red flags at the IMF. Under the agreement signed in April, Argentine authorities did not expect to intervene in the non-deliverable futures (NDF) or parallel markets unless disorderly conditions emerge. While the IMF hasn’t publicly criticized the central bank’s recent move, a person with direct knowledge said it will be reviewed as part of the formal assessment of Argentina’s monetary and exchange rate policies. An IMF spokesperson last week said “the fund continues to support the authorities in their efforts to create a more stable and prosperous Argentina,” adding that “there is a shared recognition with the authorities about the importance of strengthening external buffers.” Argentina’s central bank didn’t immediately respond to a request for comment. [...] Source: Bloomberg Article link: https://lnkd.in/eXS_bXDE #argentina #fx #emergingmarkets

Impact of RBI Forward Forex Purchases on Financial Markets The Reserve Bank’s net outstanding short position in rupee forwards indicates that it has to sell dollars in exchange of rupee on the maturity of forward sell contract in forex market say after 1 or 3 months or one year, whereas the RBI’s net outstanding long position in rupee forwards indicates that it has to purchase dollars in exchange of rupee on the maturity of forward purchase contract in forex market. Simply put, RBI’s net short position in rupee forwards indicates its ‘forward sell’ position and net long position in Rupee forwards indicates its ‘forward purchase’ position. ▪️When the Reserve Bank purchases more dollars in the forward market than in the spot markets, the Reserve Bank seeks to avoid any undue impact on rupee liquidity. The more purchase of long contracts in forwards (of 3 months to 1 year maturity) indicate that the central bank expects the rupee to weaken in the 3 month to 1 year period. While the Reserve Bank can sell dollars ( after purchasing the same in long contracts) in the spot market and thus support the rupee, such interventions result in depleting its own forex reserves and sucking rupee liquidity out of the banking system. ▪️The central bank’s accumulation of forward purchases has resulted in hiking the forward premium, especially in the 3 month forward contracts. The rise in forward premium deters importers to hedge their currency exposure while also impacting stable inflows into the bond market. ▪️The forward purchases of foreign exchange under buy/sell swap that are due to mature over the next few months can lead to injection of durable liquidity, unless rolled over. While forward forex market interventions/rollovers could relax the liquidity management challenges, such an approach carries the risk of distorting forward rates as it is influenced by demand and supply conditions. Forex interventions change significantly the composition of the RBI’s balance sheet (in terms of the sources of expansion in reserve money), which poses challenges. Thanks for reading….