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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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.
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Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
REER vs NEER (GBP/INR)
0
20
40
60
80
100
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 (GBP/INR) REER
REER vs NEER (ThaiB/INR)
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
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 (Thai Baht/INR) REER
22
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
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/
25
Contemporary Concerns Study Objectives of RBI’s Monetary Policy
11. Vietnam – General Statistics Office of Vietnam,
http://www.gso.gov.vn/default_en.aspx?tabid=462&idmid=2&ItemID=5192
26