On Sterilising Capital Inflows - The Indian Experience

This study examines the extent to which the Reserve Bank of India has sterilised its intervention in the foreign exchange market. We have estimated a monetary policy reaction function and inferred that the sterilisation of official intervention in the foreign exchange market is partial for the sample period 1975-76 to 2000-01. The evidence for a sub sample spanning April 1994 to July 2001, describing the period of market based exchange rate regime, indicates that the sterilisation is more active. However, the positive trend in exchange rate and continuous accumulation of foreign exchange reserve have led us to conclude that the RBI's direct intervention in the foreign exchange market has been mainly for the purpose of building up reserves apart from stabilising the exchange rate. This suggests that if the RBI's direct intervention in the foreign exchange market has the twin objectives of stabilising exchange rate and building comfortable foreign exchange reserves then the exchange rate stability must be supplemented by indirect monetary policy measures.