Foreign Exchange Intervention and INR/USD Exchange Rate Dynamics: Evidence from India (2013-2023)

Abstract

Purpose - This study examines the effectiveness of the Reserve Bank of India’s (RBI) foreign exchange market intervention in influencing the dynamics of the INR/USD exchange rate, focusing on exchange-rate returns and volatility.

Methodology - The analysis uses monthly data from February 2013 to November 2023 and employs a vector autoregression (VAR) framework complemented by impulse response analysis to capture the short-run transmission of intervention shocks.

Findings - Results indicate that RBI intervention does not have a significant effect on monthly exchange rate returns, suggesting that periodic interventions are insufficient to influence the rupee’s direction in a deep, liquid market. In contrast, interventions significantly reduce exchange rate volatility, highlighting their stabilising role. Impulse response analysis indicates that intervention shocks cause an immediate but short-lived appreciation of the rupee and a pronounced short run reduction in exchange rate volatility. Together, these findings suggest that RBI interventions primarily function as market-stabilisation tools aimed at containing volatility rather than targeting specific exchange-rate levels.

Research implications - These findings align with the RBI’s stated objective of managing volatility in a managed float regime and are consistent with existing evidence on central bank interventions in emerging markets.

Practical implications - The results support the RBI’s managed float framework, indicating that foreign exchange interventions are most effective at containing volatility and maintaining orderly markets.