TERM PAPER-BGS - You are being redirected...spidi2.iimb.ernet.in/~networth/CCS/2005/585 CCS - RBI... · Web viewSubmitted To Prof. Shyamal Roy On November 21, 2006 By Mrinal Vikram

Contemporary Concerns Study

SUBMITTED

TO

PROF. SHYAMAL ROY

ONNOVEMBER 21, 2006

BY

MRINAL VIKRAM (0511240)SHOBHIT KUMAR GUPTA (0511260)

Contemporary Concerns Study Objectives of RBI’s Monetary Policy

INDIAN INSTITUTE OF MANAGEMENT, BANGALORE

RESERVE BANK OF INDIA

A STUDY OF OBJECTIVES OF RBI’S MONETARY POLICY IN CONTEXT OF EXCHANGE RATES

2


TABLE OF CONTENTS

SERIAL NO. TITLE PAGE NO.

1. ABSTRACT 4

2. INTRODUCTION 5

3. EXCHANGE RATE DETERMINANTS 6

4. EXCHANGE RATE POLICY – ECONOMIC SIGNIFICANCE 6

5. EXCHANGE RATE POLICY – THEORIES 7-8

SHORT TERM

LONG TERM

6. RBI’S INTERVENTION POLICY 8

7. STABILIZATION OF EXCHANGE RATES 11

8. CONSTRUCTING A COMPOSITE INDEX 14

9. DEVIATION FROM RBI’S RESULTS 16

10. TOOLS OF POLICY IMPLEMENTATION 16

11. RESULTS 18

12. LIMITATIONS & FURTHER RESEARCH 19

13. EXHIBITS 21

14. REFERENCES 25.

3


ABSTRACT

The Central Bank in any country is entrusted with a number of responsibilities – apart

from acting as a banker to the Central Government, this is the body that formulates

and implements policies designed to keep the domestic economy in a functioning

state. These functions are performed through two main primary means – the Fiscal

Policy and the Monetary Policy. Some of these goals, at times, appear to be

contradictory and mutually exclusive. Hence, a good Central Bank has to constantly

tread a fine line and maintain a balance between these often dichotomous pulls.

In India, the Reserve Bank of India performs all of the above functions. Inspite of the

rapid changes in the domestic economic scenario post liberalization, since, the local

capital markets are not as developed as in the US and EU, the RBI retains its

premier position. All players in the economy look at the RBI not only for specific

instructions and guidelines but also for signals that might signify future courses of

action. However, given the sheer range of (often seemingly) conflicting objectives,

guessing is often reduced to plain speculation.

This report seeks to identify the objectives of RBI’s monetary policy in the context of

exchange rates. There are a number of theories in vogue that attempt to explain

RBI’s actions. However, there are very few studies that have tried to use available

data to explain predictions. This report is an attempt to verify the more prominent

ones of these theories by analyzing the available data. The primary aim of this

project is to uncover the underlying thrust of RBI’s policies when it comes to

exchange rates.

The initial part of the report looks at establishing visible trends after a rigorous

analysis of the data given. Then, the trends are verified against the theoretical

framework. Next, as the RBI does not disclose the contents and weights of the

currency index it uses; an attempt is made to replicate the index using the inflation

data and the exchange rates. Finally, the results of the replicated index are

compared with those of the actual index. An attempt has been made to explain

4

Monetary Independence

Free Capital Flow

Full Capital Controls

Unstable/Floating Exchange Rate

Currency Union

Stable Exchange Rates


discrepancies between the two and to develop a framework consistent with the

results.

INTRODUCTION

One of the basic tenets of macroeconomic policy making is that the three primary

aims of a nation’s monetary policy cannot be achieved simultaneously. This implies

that the ‘Impossible Trinity’ of:

1. Stable Exchange Rates,

2. Monetary Policy Independence (control over Interest Rates), and

3. Integration with global markets (Free Capital Flow)

can at best be achieved in parts. As the figure below shows, nations adopt various

means to reconcile these often contradictory policy goals.

Central Banks the world over choose any 2 out of these 3 to be the main focus of

their monetary policy. RBI is no different and interferes in the markets on a regular

basis. However, the specifics of RBI’s policy are not well-understood.

5


This study is an attempt to understand the motives of RBI’s policies in context of

exchange rate regime in the country. Towards the end, means used by the RBI to

implement its policies without adversely affecting other aspects of economy are

analyzed.

EXCHANGE RATE DETERMINANTS

The main underlying factors affecting the exchange rates are:

1. Domestic causes such as the strength of the economy, the balance of

payments and the remittances– the so-called fundamental factors (or

fundamentals)

2. Interest rate differential with developed markets (primarily the US and the

Euroozone)

While seeking to maintain a stable exchange rate, RBI has to take into account both

these factors. The second factor (interest rate differential) is gaining prominence in

an increasingly globalized economy, mainly because of the significant amount of

capital coming in from foreign investors, and the ease with which this capital can

move across boundaries. In the recent past, RBI has often cited Fed rate hikes as a

reason for increasing the domestic interest rates to curb capital outflow.

EXCHANGE RATE POLICY – ECONOMIC SIGNIFICANCE

The RBI’s policy on exchange rates is probably the most closely followed and

the most debated as well. This is because of the direct impact the policy has on

the competitiveness of the economy. In an increasingly globalized economy and

in an era of intense competition, even a small adverse movement in exchange

rates can hit the country’s exports and disrupt the trade balance.

This is true not only for exporters but also for the general economy as a whole.

A small movement in rates can make imports cheaper, thus aiding the foreign

producers and hitting the domestic ones. Similarly, depreciation in local

currency can make the imports prohibitively costly, thus affecting the entire

6


economy. This is especially true of a country like India where almost a third of

the import basket consists of oil and a small movement in exchange rates can

have a trickle down effect on the entire economy. Further, in a country with net

negative balance of payments, this could lead to a further worsening of trade

balance. Of course, there is always the added possibility of speculation on

currency gaining prominence.

The next section looks at some of the widely accepted theories about the

exchange rate policy. The subsequent sections make an attempt at empirical

verification of these.

AIM OF RBI’S EXCHANGE RATE POLICY - THEORIES

Short Term

Given the importance of stable exchange rates, there is almost a common market

consensus on the contention that RBI seeks to avoid undue and violent fluctuations

in the foreign currency market on a day-to-day basis. There is sufficient empirical

evidence of this as the RBI intervenes directly in the market whenever there is a

sudden change in the exchange rates which is not warranted by fundamentals. One

might therefore argue that the RBI does not have any explicit target in mind. All it

seeks to do is to smoothen out the volatility. Intuitively too, it makes sense as without

the intervention, the speculators can have a field day – thus affecting the country’s

trade position adversely. The timing of RBI’s intervention (that is, the exact definition

of a violent movement) and the extent of intervention is, of course, debatable but

almost everyone is in agreement over the short-term objective of calming the markets

down and giving some semblance of stability to them.

Long Term

However, things are not as clear once it comes to long-term objectives. One common

hypothesis is that the RBI looks to maintain the exchange rate stable in nominal

terms. This appears to be a tempting and simple explanation of the relative stability

the Rupee has enjoyed over the recent past (when it has been moving within a band,

for instance, against the US Dollar). Also, this seems to be just an extension of the

short-term policy and thus is easier to implement.

7


On a closer inspection, however, this does not seem to be so tenable because of the

related issue of maintaining stability against all major currencies. In case, the stability

is maintained only with a couple of currencies, there might be an opportunity to make

arbitrage profits by exploiting both the interest rate and the price level (or inflation)

differentials between the Rupee and the other currencies. A solution to this could be

using a weighted average of all major currencies as the standard against which the

Rupee would be kept constant. However, as the subsequent analysis shows, this is

not borne out when we do a rigorous data analysis of the movements in rates.

A possible alternative could be to maintain the exchange rates stability on a real

basis. This would require the RBI to take the price level (through an index like the

Consumer Price Index) into account too. Using the individual price data, the RBI can

maintain the Rupee constant on a ‘Real’ basis. In this case, there would be no

opportunity for arbitrage profits based on the inflation differential. The only differential

would be the interest rate differential but that is taken care of by the different country

risk profiles. Also, as before, the RBI can use a weighted index of currencies as the

benchmark for stabilization.

From a policy point of view, maintaining the Rupee constant on a real basis would

imply maintaining the export competitiveness constant. This is desirable as letting the

Rupee appreciate adversely affects the exports while depreciation leads to imports

getting affected. This, in turn, leads to a distortion in trade balance which, in turn,

affects the balance of payments. In extreme cases, this could also lead to a spiraling

situation which could easily spin out of control (where worsening trade balance leads

to further pressure on currency leading to an ever worsening trade balance). This is

discussed further later.

The subsequent sections aim to study the data available and test both the

explanations for consistency with data.

RBI’S INTERVENTION POLICY

The first aim of this report is to study how the RBI takes a decision regarding when to

intervene in the Exchange rate market.

As discussed above, the aim of the Reserve Bank’s exchange policy has been the

subject of much speculation. While some speculate that the aim of the exchange

policy is to keep the Nominal Effective Exchange Rate stable and minimize

8


fluctuations, others believe that the Reserve Bank aims to have a steady Real

Effective Exchange Rate (REER). Still others believe that although the RBI wants to

minimize fluctuations in the NEER, it is quick to intervene whenever the Rupee

appreciates against a major currency like the US Dollar but, if the Rupee depreciates;

it lets it weaken to some extent before intervening.

A cursory glance at the country’s forex reserves supports the hypothesis. This

suggests that RBI has been indulging in Open Market Operations – buying up dollars

(or any other foreign currency) to halt Rupee’s appreciation. (Exhibit 1)

While letting the Rupee depreciate might help exporters by making exports cheaper

and imports costlier, it might also be detrimental to the economy in the long run. This

is because, India has a net negative balance of payments i.e. the Indian economy is

a net importer of goods. Therefore, a weakening Rupee can further weaken India’s

balance of trade.

Data AnalysisNominal Rate

In this study, this hypothesis is verified by analyzing the daily spot USD/INR nominal

exchange rate since 2000. For the purpose of this study, the data points were split

into 14 data sets of 6 month data each. For each of these data sets, a trend line was

fit in by regressing the data set with an arithmetic progression with a common

difference of 1.

Under the hypothesis, the number of downward movements in USD/INR (implying

appreciation of Rupee) should be lesser than the number of upward movements.

This implies that the RBI intervenes when Rupee appreciates and lets Rupee

depreciate. Also, the magnitude of the downward movement should be lesser than

the magnitude of upward movement.

9


Analysis of Intervention by RBI

42

43

44

45

46

47

48

49

50

Jan-00 Sep-00 May-01 Jan-02 Sep-02 May-03 Jan-04 Sep-04 May-05 Jan-06 Sep-06

USD/

INR

Spot

Rat

e

USD/INR Trend

Data Source: US Federal Reserve Database, St. Louis

The absolute value of the difference between the trend value and the actual

exchange rate is the deviation from the trend. The maximum value of positive

deviation (1.2676) from the trend is relatively smaller than the maximum value of the

negative deviation (1.6316). However, the total number of 3 consecutive upward

movements is 120 which is very close to the maximum number of 3 downward

movements (117). The count for 2 consecutive upward movements or downward

movements is close too.

Therefore, the analysis can best be termed as inconclusive i.e. it cannot be said that

the RBI lets the INR depreciates to some extent without intervening but, is quick to

intervene if the INR appreciates against the USD.

The results are tabulated below.

Maximum Upward Deviation 1.2676

Maximum Downward Deviation 1.6316

Upward Movements 732

Downward Movements 756

3 Consecutive Upward Movements 120

3 Consecutive Downward Movements 117

10


Real Rate

An extension of the hypothesis can be that the RBI does not intervene to regulate the

nominal rates but does so only in the case of Real rates. This implies that RBI allows

the Rupee to depreciate in real terms to allow Indian exports to become more

competitive.

A similar analysis is carried out on real exchange rates with respect to the US Dollar.

The results are tabulated below.

Maximum Upward Deviation 1.3697

Maximum Downward Deviation 0.9079

Upward Movements 41

Downward Movements 37

3 Consecutive Upward Movements 17

3 Consecutive Downward Movements 14

Again, it is difficult to draw a concrete conclusion from here. The data does seem to

suggest that in real terms, RBI has been partial to Rupee depreciating (thus

encouraging export competitiveness). Still, the results can at best be termed as

inconclusive, with a slight bias in favor of the hypothesis.

However, as the analysis was performed with data on a monthly basis (as the price

data is available only on a monthly basis), more reliable conclusions should be drawn

only with more detailed data sets.

STABILIZATION OF EXCHANGE RATES

Another hypothesis can then be that the aim of the Reserve Bank’s exchange policy

is to stabilize the Real Effective Exchange Rate of the INR against other global

currencies. To test this hypothesis, we calculated the REER of the INR with respect

to 10 leading currencies of the world. The criteria used to select the 10 currencies

were as follows:

1. The corresponding economies should be important destinations for Indian

exports. To keep Indian exports competitive the RBI would then like to keep

the REER stable.

11


2. The currencies should be important to world trade - the USD or the Euro, for

instance.

3. The currencies should be representative of a geographical region – the

Brazilian Real for Latin America, for instance.

4. Information on the Consumer Price Index of the corresponding economies

should be available to calculate the REER. Because of unavailability of CPI

information from the UAE, the UAE Dirham was not included (inspite of

satisfying most of the other criteria)

The relative importance of a currency for the RBI in deciding its exchange rate policy

depends on the following two criteria:

1. If the corresponding economy is an important destination for India’s exports,

having a stable REER ensures that Indian exports do not suffer.

2. If the corresponding economy is a competing source of goods which form an

important part of India’s export basket. In this case, maintaining the REER

constant would ensure parity on a global scale, i.e., no country would have a

head-start solely on the basis of exchange rates.

On the basis of the above criteria the following 10 currencies were selected:

US Dollar

British Pound Sterling

Euro

Japanese Yen

Thai Baht

Hong Kong Dollar

Singapore Dollar

Indonesian Rupiah

Vietnamese Dong

Brazilian Real.

Analysis Methodology

To calculate the REER, we used the Consumer Price Index (CPI) for the

corresponding economies. The REER was then calculated as follows:

12


REER(Currency(X)/INR) = NEER(Currency(X)/INR)*CPI(X)/CPI(India)

where X denotes the foreign country and NEER is the spot exchange rate prevalent.

The REER for each of the 10 currencies was then plotted against the NEER to

identify trends. To get a measure of the relative scale of fluctuations in the NEER

with respect to the REER, we computed the coefficients of variations for the NEER

and the REER. Coefficient of Variation is defined as the ratio of standard deviation

and average. By comparing the magnitudes, it gives a much better idea of variability

in data.

Coefficient of VariationCurrency NEER REER

USD 16.89% 4.83%GBP 18.70% 6.55%EUR 12.09% 9.05%Thai Baht 10.17% 18.78%Indonesian Rupiah 1.55% 6.35%Brazilian Real 30.33% 23.47%Japanese Yen 16.83% 14.13%Vietnam Dong 313.37% 311.77%Hong Kong Dollar 16.61% 11.13%Singapore Dollar 2.51% 6.68%

Except for Singapore Dollar, Thai Baht and the Indonesian Rupiah, the coefficient of

variation for the NEER was lower than that for the REER. So, on an average the

REER is much more stable than the NEER for 7 of the 10 currencies. Even for the

three currencies, the fact that these were the three currencies most affected by the

East Asian Crisis of 1997-98, is likely to have distorted the data. The crisis period

saw currencies losing as much as 50% of their value in less than a month. As the

economies recovered, the currencies would have gained some of that lost value (as

dictated by fundamentals). This is likely to have affected the results.

The graph below shows a representative currency and its movement against the

Rupee.

13


REER vs NEER (USD/INR)

0

10

20

30

40

50

60

Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06

Date

Exch

ange

Rat

e (M

onth

ly)

NEER (USD/INR) REER

As can be seen, REER is almost constant over a 15 year period. On the other hand,

NEER has drifted away from the starting point. Exhibit 2 shows similar results for

some other currencies.

CONSTRUCTING A COMPOSITE INDEX

The analysis done above throws up some interesting results. It appears to be very

clear that the RBI has been maintaining the Rupee constant against major currencies

in real terms. This can then be taken one step further by computing a composite

REER index based on India’s exports. The currencies selected for this basket and

the weight assigned to each of them depends on the destination of India’s exports.

On the basis of the importance of the corresponding economies for Indian exports,

the following 8 currencies were selected:

US Dollar

British Pound Sterling

Euro

Japanese Yen

Thai Baht

Hong Kong Dollar

Singapore Dollar

14


Brazilian Real

Again, certain currencies (like the Brazilian Real) are included as they are

representative of a particular region (Latin America in this case). To compute the

weights assigned to the currencies, we computed the percentage of India’s exports to

the corresponding economy. These weights were then normalized to add up to 1.

The 8 currencies mentioned above together account for approximately 60% of India’s

exports.

Because the relative importance of an economy to the exports does not change

soon, the weights calculated from the annual exports composition were used to

calculate the composite REER for each month in the year.

The RBI also releases 3 different kinds of REER figures calculated with:

1. A 36 Currency Trade Based weights basket

2. A 36 Currency Export Based weights basket

3. A 6 Currency Trade Based weights basket

However, no information is available on the composition of the basket or the weights

assigned to the currencies. These figures can then be compared to our 8 currency

export based weighted basket for trends.

The variations from the mean as measured by the Co-Variation for the 4 measures

were as follows:

NEER REER

RB

I's In

dice

s

Trade Based Weights (5-6

Currency) (Base April 2000) 3.43% 4.47%Trade Based Weights (36 Currency)

(Base April 2000) 2.44% 6.05%Export Based Weights (36 Currency)

(Base April 2000) 2.14% 6.02%

Proposed Export Based Index (8 Currency) 12.55% 7.21%

As can be seen, the REER shows a much higher variation than the NEER for each of

the 3 RBI indices. However, for our 8 currency export based basket, the variation

15


form the NEER is significantly more than that for the REER. The graph below shows

the results.

Proposed 8 Currency Index

80

90

100

110

120

130

NEER REER

Therefore, it can be postulated that the RBI in deciding its exchange rate policy looks

at maintaining a stable REER with respect to some of the more important currencies

than the rest. As discussed above, an index of currencies with India’s export share

with them as weights can be used as a benchmark. Exhibit 3 shows NEER and

REER curves for RBI’s indices.

DEVIATIONS FROM RBI’S RESULTS

As shown above, our results differ considerably from the results that RBI provides

(through its REER and NEER indices).

The following are a few of the possible explanations for the deviation of our results

from those acquired from the Reserve Bank of India:

1. The basket used by the RBI to calculate the REER index (Trade

Based/Export Based) is not known. We do not know which currencies have

been included in the trade basket or what weights have been assigned to

them. We however, know that the number of currencies included is either 6 or

36 while for our index, the number stands at 8. However, the 8 currencies

together account for approximately 60% of India’s export basket (consistently

over a period of 7 years).

16


2. We also do not know how the REER was calculated for the individual

currencies i.e. which Price Indices were used for India and the corresponding

economies to calculate the REER.

3. Data for certain important currencies (like the UAE Dirham) is not readily

available (it started to get published only in early 2006). Thus, these

currencies were not taken into account for calculation of the index.

TOOLS OF POLICY IMPLEMENTATION

The second aim of the report is to try to understand the nature of RBI’s interventions.

In recent years, in spite of the India’s negative balance of trade, there has been a net

inflow of foreign exchange to India mostly by the FIIs and the FDIs who recognize the

growth potential of the country. Therefore, left to itself the INR would have

strengthened against major global currencies like the USD and the Euro. However,

as is evident, the INR has if anything demonstrated a downward trend over the past 6

years. This is because of the RBI’s policy of buying forex from the market through

Open Market Operations in exchange for INR. This has been a major reason for

India’s swelling forex reserves (Exhibit 1).

However, such an action also increases the supply of high powered money in the

economy which can lead to an increase in inflation. Therefore, to insulate the money

supply, the RBI sucks out the liquidity from the economy by selling government

securities again through open market operations – Sterilization of domestic money

supply. This method however, might not be of much use to the RBI for long due to

the dwindling number of government securities that are available with the RBI for

OMOs. RBI has lately also introduced new securities like the Market Stabilization

Bonds (MSBs) for this purpose only.

If the RBI is following such a policy then an analysis of the total money supply in the

economy can be used to support the hypothesis. We provide such an analysis of the

high powered money supply (M3) in the economy.

17


M3 Money Supply Monthly Basis (Jan '00 - May '06)

-

500

1,000

1,500

2,000

2,500

3,000

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06

Rs.

(in

'000

cro

res)

M3 Money Supply Linear (M3 Money Supply)

Data Source: Reserve Bank of India Database

It is evident that the rate of money supply growth in the economy has had a stable

growth rate in spite of the forex inflows. As the trend-line shows, the money supply

has been growing steadily (at roughly the same annual rate), thus implying an

emphasis on sterilizing the money supply. This shows that the RBI has been

involved in insulating the money supply.

Another option for the RBI to stabilize the exchange rates is to try to regulate inflows

of forex into the economy. This can be done by:

1. Direct regulation, for instance, by regulating the amount of deposits NRIs can

make with Indian banks or by placing limits on the minimum time period these

deposits can be made for.

2. Traditionally interest rates in India have been much higher than those abroad.

This has been a major reason for the influx of funds from abroad. By lowering

interest rates in India, the amount forex inflow can be regulated. However,

domestic interest rates in India are downwardly rigid due to high financial

intermediation costs, administered interest rates in the small segments, on-

performing assets of financial institutions and other related factors.

18


RESULTS

According to our study of the Real Effective Exchange rates of the INR with respect

to 10 of the leading currencies of the world, the REER shows much lesser

fluctuations as compared to the NEER. We computed an 8 currency export based

REER index which shows a similar behavior. The coefficient of variation of the REER

is smaller than the NEER. We compared this observation with those for the 3 REER

indices available from the RBI. This data however, shows a reverse behavior i.e. the

REER shows a significantly higher degree of fluctuation than the NEER.

It was also found that the mechanism used by the RBI to maintain a stable REER is

by buying forex and insulating the money supply through OMOs. An analysis of the

OMOs shows that the RBI has been a net seller of government securities each

month over the past years (Exhibit 4). Therefore, the amount of government

securities available with the RBI to perform OMOs is fast dwindling. Therefore,

insulating the money supply is not a sustainable mechanism to stabilize the

exchange rate.

Another point worth mentioning is that India was one of the few important Asian

economies to escape the Asian Crisis of 1997-98 unscathed. This could mainly be

attributed to market discipline that the RBI enforces through its constant market

intervention. By ensuring that the Rupee does not deviate too much from what the

fundamental factors dictate, the RBI does not leave too much space for speculators

to play around with. This prevents a currency bubble (of the kind witnessed in Asian

Crisis) from building up.

Going forward, RBI should consider other alternatives such as fixing the downward

rigidity of interest rates. A weak INR is not the best possible mechanism to promote

Indian exports. Trade liberalization and increased competitiveness and efficiency of

Indian industries is the only way to go.

LIMITATIONS & FURTHER RESEARCH

We would also like to mention here some of the limitations of our study:

1. Some of the economies which are important destinations for Indian exports

have not been included in the study or in the calculation of the REER index.

This is because Price Index data for these economies were not available. E.g.

19


A large part of the Indian export basket comprises of exports to the UAE.

However, till recently the UAE did not publish an aggregate price index on the

lines of the Consumer Price Index available for other economies. Therefore,

data for the UAE Dirham was not included in the study.

2. Some of the other economies such as that of China are increasingly

becoming important parts of the Indian export basket. The Chinese currency

is pegged to the US Dollar. Therefore, in calculation of the aggregate REER

index, a higher weight might be assigned to the USD to compensate for

Indian exports to China.

3. Presently the study has been done using the Consumer price indices for the

various economies to calculate the REER. A similar exercise can be done by

using other price indices like the equivalent of the Wholesale Price Index

(WPI).

4. A large chunk of Indian exports (approximately 40%) are to economies that

individually account for less that 1.5% of the total exports. Including some of

these currencies to calculate the REER index might make the Index more

accurate. Having said this, it should also be pointed out that we can safely

assume that while setting an exchange policy for itself, the RBI would look at

the REER of the INR with respect to 8 or 10 major currencies instead of a

larger number. Therefore to accurately predict what effects the exchange

policy, a study with 8 major currencies might be adequate.

5. Also, data for Consumer Price Index is normally available on a monthly basis.

Possibly, using the data on a weekly (or even fortnightly) basis would be more

indicative.

20


EXHIBITS

Exhibit 1

The foreign exchange reserves have been constantly growing suggesting

intervention by the RBI (even after accounting for the relatively high levels of

remittances in the recent past) to buy up US dollars.

Forex Reserves

0

50

100

150

200

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06

Billi

ons

of U

SD

Forex Reserves

Source: www. indiastat.com

Exhibit 2

21


REER vs NEER (GBP/INR)

0

20

40

60

80

100


Date

Exch

ange

Rat

e (M

onth

ly)

NEER (GBP/INR) REER

REER vs NEER (ThaiB/INR)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6


Date

Exch

ange

Rat

e (M

onth

ly)

NEER (Thai Baht/INR) REER

22


Exhibit 3

RBI's Indices (Trade Based)

80

90

100

110

120

130

Apr-00 Apr-01 Apr-02 Apr-03 Apr-04 Apr-05 Apr-06

NEER (36 Currency) REER (36 Currency)

Data Source: Reserve Bank of India’s Database

RBI's Indices (Trade Based)

80

90

100

110

120

Apr-00 Apr-01 Apr-02 Apr-03 Apr-04 Apr-05 Apr-06

NEER (6 Currency) REER (6 Currency)

Data Source: Reserve Bank of India’s Database

Exhibit 4

23


As the graph below shows, over the last 5 years, RBI has been a net seller of

securities. This strengthens the hypothesis of RBI intervening in the market to buy up

US dollars and then sterilizing the money supply.

The scale on the right shows that net purchases have been lower than net sales by

an order of 100 (or even greater).

Open Market Operations by RBI

0

4000

8000

12000

Apr-02 Apr-03 Apr-04 Apr-05 Apr-06

Rs. (

in c

rore

s)

-100

100

300

500

700

900

1100

1300

1500

Rs. (

in c

rore

s)Net Sales of Securities Net Purchases

REFERENCES

24


M. Ramachandran, “The conundrum of exchange rate policy”, The Hindu,may

24, 2004,

http://www.hindu.com/biz/2004/05/24/stories/2004052400371600.htm

Exchange rates - Oanda, http://www.oanda.com/convert/fxaverage

Sources for Consumer Price Index for various currencies:

1. United States of America - Economic Research, Federal Reserve Bank of St.

Loius, http://research.stlouisfed.org/

2. United Kingdom – National Statistics and ONS

http://www.statistics.gov.uk/cci/nugget.asp?id=19

3. Euro Zone – Eurostat, Economic and Monetary Affairs, European Union,

http://epp.eurostat.cec.eu.int/portal/page?

_pageid=1194,47855178,1194_47870923&_dad=portal&_schema=PORTAL#

CP

4. Brazil – Insituto Brasiliero de Goegrafia e Estatistica,

http://www.ibge.gov.br/english/default.php

5. Hong Kong – Census and Statistics Departments, The Government of Hong

Kong, SAR of the People’s Republic of China,

http://www.censtatd.gov.hk/home/index.jsp

6. India – Labour Bureau Government of India,

http://labourbureau.nic.in/indnum.htm

7. Indonesia - Badan Pusat Statistik (BPS-Statistics Indonesia),

http://www.bps.go.id/sector/cpi/

8. Japan – Statistics Bureau, Ministry of Internal Affairs and Communications,

http://www.stat.go.jp/english/data/cpi/index.htm

9. Singapore – Singapore Department of Statistics,

http://www.singstat.gov.sg/press/cpi.html

10. Thailand – National Statistical Office, Thailand, http://www.nso.go.th/

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11. Vietnam – General Statistics Office of Vietnam,

http://www.gso.gov.vn/default_en.aspx?tabid=462&idmid=2&ItemID=5192

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