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CHAPTER 4
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To analyze the effectiveness of RBI intervention on exchange rate level and volatility.
To verify the relevance of asymmetric intervention.
Chapter 4 of the thesis empirically estimated two models to analyze the above two objectives using monthly data from July 1995 to July 2013. First model analyzes the effect of intervention on the exchange rate level and volatility by measuring intervention as net purchases of US dollar by the RBI. In second model, we include both purchases and sales of US dollar, instead of net purchase, to analyze the effect of asymmetric intervention on exchange rate level and volatility. Both models are estimated by employing GARCH methodology. The results based on model I show that RBI intervention is not effective in influencing the level of Rupee/USD exchange rate.
However, in the case of exchange rate volatility, the study found that the RBI intervention is effective in reducing the volatility.
The empirical findings of the second model provide some evidence of „leaning against the wind policy‟ during the period of appreciation, and „leaning with the wind policy‟
during the period of depreciation of rupee against the US dollar. Further, the empirical findings show that intervention by purchases significantly reduces volatility whereas intervention by sales significantly increases volatility of exchange rate. This indicates that RBI effectively reduces exchange rate volatility during the period of exchange rate appreciation of rupee against the US dollar in the foreign exchange market whereas intervention by sales of US dollar, during the period of depreciation, does not lead to any reduction in volatility of exchange rather it increases volatility.
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This finding has some policy implications. First, if RBI wishes to target the level of exchange rate, then it has to intervene with huge amount of purchases and sales relative to market turnover. It implies that the existing size of intervention is not sufficient to target the level of exchange rate.
Second, since the study found that the intervention by sales increase risk in the market and thus the RBI may have to come-up with certain policies which enhance its credibility while intervening through sales.
This study has two limitations. First, this study used monthly data to analyze all the dynamics of intervention due to the lack of availability of daily data. However, the daily data will be more appropriate to capture the intervention dynamics. Second, the asymmetric impact of intervention can be further studied with the help of most recently developed asymmetric methods such as E-GARCH and T-GARCH etc. This research issue can be further studied.
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