India's forex reserve adequacy helped maintain investor confidence: BIS

India's improved forex reserve adequacy helped maintain investor confidence and improved policymakers' room for maneuver, according to a report prepared by the Bank for International Settlements (BIS). India maintained forex reserves upwards of USD 550 billion during most of 2022.

Deeper and more liquid FX markets

BIS is an international financial institution owned by member central banks with the primary goal of fostering international monetary and financial cooperation. Several members noted that developing deeper and more liquid FX markets in the past facilitated efficient price discovery during 2022 and reduced the need for FX interventions or capital flow measures (CFMs), including China, Indonesia, and Malaysia, the report said.

Hedging requirements

In addition, minimum hedging requirements on corporates' net liability exposure in the past helped build firms' resilience and also mitigated the need for or intensity of an ex-post policy response in 2022, the report titled Inflation, external financial conditions, and macro-financial stability frameworks in Asia-Pacific said.

Improved FX reserve adequacy

In a similar vein, improved FX reserve adequacy helped maintain investor confidence and improved policymakers' room for maneuver, for example in India, it said. India announced several measures to liberalize capital flows in July 2022 while taking steps to ensure overall macroeconomic and financial stability to stem the decline in forex reserves.

FX-related macroprudential measures

During 2022, it said, many regional economies saw the use of FX-related macroprudential measures or other CFMs. A selection of these measures included increasing the limit for external commercial borrowing and relaxing restrictions on foreign investment in debt markets (India), having in place limits on domestic currency lending or borrowing by non-residents without an underlying trade or investment (Thailand), and limits on foreign investment in certain sectors (Vietnam), it said.

Communication policy

Observing that several central banks noted the use of communication policy, the report said regular communication as part of the monetary policy process helped keep inflation expectations anchored in India and Malaysia. Effective policy communication helped anchor inflation expectations and thus assisted in maintaining stability, it said.

Forward guidance

In India, it said, apart from forward guidance, communications were also used to explain the rationale for the measures being taken by the RBI, while also seeking to inspire confidence and optimism for the general public during the Covid pandemic.

Exchange rate flexibility

While a flexible exchange rate was generally seen as a shock absorber for external price shocks, some authorities used FX interventions to minimize the risk of excessive exchange rate movements, especially depreciations, and thus dampen the pass-through to inflation, for example, the Philippines and Vietnam, it said. Relatedly, exchange rate intervention also helped anchor expectations and facilitated the overarching objective of maintaining macroeconomic stability and market confidence, for example in India, it added.

The report by the BIS highlights the importance of maintaining adequate forex reserves, implementing macroprudential measures, and effective communication in managing external financial conditions and maintaining macroeconomic stability. The experiences of countries in the Asia-Pacific region, including India, provide valuable lessons for policymakers in addressing the challenges posed by global economic and financial developments.