‘Defending a Falling Currency is Dangerous’
The over-reliance on a single currency for global trade puts the system at risk, says RBI guv

Times of India BUREAU MUMBAI 19th April, 2013

The Reserve Bank of India governor, Duvvuri Subbarao, said the attempts by central banks of emerging markets to defend a sliding currency are akin to catching a falling knife, and the global financial system may be best served by more than one reserve currency.

Depleting the reserves arsenal at a time of weakness will leave the central banks exposed and failure to defend it against the market tide will cause more harm than good, he said.


“When you are fighting currency depreciation, you are intervening in a hard currency. Your capacity to intervene is, therefore, limited by the size of your forex reserves,” Subbarao said at the International Monetary Fund Conference in Washington.

“What complicates the dilemma is that the market is aware of this. It should also be clear that a failed defence of the exchange rate is worse than no defence. So, when you are intervening in the forex market, it is important to make sure that your intervention is successful.”

The Indian corporate lobby criticised the RBI for its limited intervention in 2011 when the currency was pummelled.
Although the central bank took some harsh measures to curb speculation, its approach was to make minimal intervention in the market as it believed the reserves were limited.

RBI’s stated goal on currency is that it will intervene only to smoothen the volatility and not target a level.

On Thursday, the rupee ended 0.4% higher at 53.97 to the US dollar.
India’s foreign exchange reserves, which crossed $300 billion before the 2008 credit crisis, have been weakening ever since. Indeed, the nation’s vulnerability has worsened with overseas borrowing climbing substantially in the last five years as companies took advantage of low interest rates overseas.

“There is the real danger that by intervening in the forex market, you could end up losing forex reserves and not gain on the currency,” said Subbarao. “The lower your reserves dip, the more vulnerable you become. And the vulnerability can become quite serious if your reserves go below the level markets perceive as necessary to regain market access.”

The foreign exchange reserves have fallen to about $290 billion, just enough to fund about 6-8 months’ imports; in May 2008, there were enough reserves to fund 15 months imports.

Over the past decade, India has had to intervene whenever the currency has appreciated or depreciated.

RBI was defending a strong currency for most part of the last decade when it was seen piling up huge reserves.

Subbarao said though central banks have succeeded in preventing a total collapse of the global financial system through their synchronised action, the fault lines have not vanished.

The over-reliance on a single currency for global trade is keeping the system at risk, he said. “The crisis has illustrated the threat to global stability because of a single reserve currency,” said Subbarao. “Till alternatives to the single reserve currency emerge, what are the obligations of the US as the issuer of the sole reserve currency? In particular, what are its obligations to EMEs whose currencies are not yet fully convertible on the capital account?”