One of the pre-crisis consensus that intervention in the foreign exchange is sub-optimal no longer holds in the current economic environment, Reserve Bank of India Governor Duvvuri Subbarao said on Wednesday.
That argument is no longer relevant as some of the advanced economies have started to defend their currencies from the safe haven impact, he said in remarks at an International Monetary Fund conference in Washington on Wednesday. The text of the speech was posted on the central bank website on Thursday.
Subbarao said for emerging markets, forex intervention poses a "complex" policy dilemma in the event of capital inflows. He also noted there is a significant asymmetry between intervention for fighting currency appreciation and intervention for fighting depreciation.
The real danger is that "by intervening in the forex market, you could end up losing forex reserves, and not gaining on the currency," he said. "A failed defense of the exchange rate is worse than no defense," the policymaker said, adding that it is important to make sure that the intervention is successful.
On capital controls, Subbarao said India's experience demonstrates that quantity-based controls are more effective in the short-term, but can also be distorting, inefficient and inequitable. He was of the view that capital controls may not be substituted by prudential measures.
If capital inflows are intermediated through the banking system, then prudential measures can be applied directly on domestic banks and if the inflows are direct, the only mechanism to prevent excessive leverage may be by imposing controls, Subbarao said.
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