India needs foreign exchange reserves to buffer to tackle exchange rate volatility
India requires foreign exchange buffer reserves to protect itself from exchange rate volatility as we have none of the friends for swap lines and Japan was the only country that assisted during the taper tantrum in 2013, explained former RBI Governor Raghuram Rajan on Tuesday.
Taking part in a virtual event organized by economic think tank NCAER, Rajan explained during the taper tantrum in 2013, India asked for swap lines, and the only country that helped us was Japan
“We asked for swap lines, that is on public record, we did not get them. The only country who assisted us during the taper tantrum was Japan,” he explained.
Taper tantrum suggests emerging markets facing inflation woes and other issues after the US Federal Reserve decided to put brakes on its quantitative easing proposal in 2013. The proposal was started to handle the fallout of the 2008 global financial crisis.
So when you have no external support, you have to build your support, which is why we began building the reserve buffer,” Rajan explained, adding that what happened during the taper tantrum was a traumatic experience for many who went through it.
Rajan reported that he can’t see an Indian government going to the IMF and saying I need a contingent plan, even though, to the IMF’s credit, it is explained frequently. “This should not be a source of stigma,” he explained.
As per RBI data, the country’s foreign exchange reserves swelled by $1.013 billion to touch a lifetime high of $610.012 billion in the week ended July 2.
So broadly speaking, I would say, you can keep this regime at the margins, but it acted for us.
“It is not the long-term regime that we should have, hopefully as we create credibility for inflation targeting and we boost our institution, we can move away from it,” the former RBI Governor explained.
Stating that India moved into an inflation-inflation regime in 2014-15, he explained, “When you try to lessen volatility then you do improve a variety of sources of moral hazards. One of the downsides of intervention is it breeds extra intervention”.
The Reserve Bank of India (RBI) has the mandate to protect retail inflation at 4 per cent with a margin of 2 per cent on either side. The central bank’s member monetary policy committee (MPC) headed by the RBI Governor decides on policy rates keeping this target in mind.
Rajan also explained that ultimately a country can get rid of the need of managing the exchange rate in two ways.
“One is to create credibility for your inflation targeting and second is if your financial system and your access to the international capital market is unimpeachable and hence people believe that movements in the exchange rate etc will not somehow impair your access.
“That also employs a different kind of credibility, straightening of the capital market institutions,” he explained