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Informist, Thursday, Feb. 27, 2025

NEW DELHI – The International Monetary Fund has maintained its classification of India's de facto exchange rate arrangement as 'stabilized' for December 2022 to November 2024, even as the exchange rate has depreciated moderately since November, saying more observations are necessary to determine new trends.

"The rupee's exchange rate flexibility has increased in recent months. However, significant FXI (foreign exchange intervention) has continued in periods outside of disorderly market conditions, potentially impeding the exchange rate's role as an absorber of external shocks," the IMF said in its Country Report titled India: 2024 Article IV Consultation, on Thursday.

In December 2023, the IMF had reclassified India's de facto exchange rate regime for December 2022 to October 2023 to 'stabilized' arrangement from 'floating'. India's de jure exchange rate arrangement has been classified as 'floating', the multilateral body said.

The classification of the de facto exchange rate arrangement is based on a statistical methodology that is implemented by the IMF staff evenhandedly across member countries. The methodology follows a backward-looking statistical approach that relies on past exchange rate movement and historical data. Therefore, this classification does not imply statements or views on future or intended policies, nor does it imply a policy commitment on the part of the country authorities.

The IMF directors recommended greater exchange rate flexibility as the first line of defence in absorbing external shocks, with foreign exchange interventions limited to addressing disorderly market conditions. However, some of them also saw the need for foreign exchange interventions in other cases, noting limitations in the current global financial safety net.

"During periods of global financial stress leading to destabilizing premia, FXI (foreign exchange intervention) can play a supporting role to improve market functioning and mitigate adverse impacts on output and inflation," it said.

However, the report said that given India's relatively low foreign exchange mismatch, well-anchored inflation expectations, and a generally deep foreign exchange market, the flexible inflation targetting framework should be supported by greater exchange rate flexibility, allowing the currency to adjust in response to external shocks while maintaining domestic price stability. "Greater exchange rate flexibility would reduce the need for holding costly precautionary FX reserves, promote FX market development, prevent moral hazard by encouraging firms to actively manage their currency risk through hedging, and reduce fluctuations in domestic financial system liquidity," it said.

In response to the IMF officials' remarks and recommendations, Indian authorities reiterated that the exchange rate of the rupee continues to be market-determined, and that foreign exchange intervention, if and when undertaken, aims to contain excessive volatility and maintain orderly market conditions without targeting any specific value of the exchange rate.

Indian authorities noted that the Reserve Bank of India's exchange rate policy has remained consistent over the years, and is focused on maintaining orderliness and stability, without compromising market efficiency. "The exchange rate of the Indian Rupee is determined by market forces. As a matter of fact, the INR/USD (rupee/dollar) exchange rate has moved in a narrow band in the recent past, reflecting low overall macroeconomic volatility then as captured in the VIX index for India," it said. As in the past, exchange rate flexibility continues to be the first line of defence in absorbing external shocks, the authorities added.

The authorities also highlighted that IMF staffs' observation that greater exchange rate flexibility would reduce the need for holding costly precautionary foreign exchange reserves confirms the fact that India's official foreign exchange reserves being at about 105% of the IMF's composite metric as at the end of December are adequate for precautionary purposes. Further, they asked the IMF staff to let them know their assessment on official foreign exchange reserves if the exchange rate regime is treated as de facto floating.

Moreover, the authorities negated the IMF officials' recommendation of keeping greater exchange rate flexibility to prevent moral hazard by encouraging firms to actively manage their currency risk through hedging, saying that hedging costs over longer horizons are significant and 100% hedging robs the borrowing cost advantage that motivates firms to borrow in foreign currency in the first place. Therefore, 100% hedging may be sub-optimal, they said.  End

Reported by Pratiksha

Edited by Ashish Shirke

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