Context: The World Bank has praised the Reserve Bank of India’s handling of the rupee’s exchange rate, calling it consistent and effective in managing volatility. The RBI clarified that its interventions aim to smooth excessive fluctuations without targeting a fixed exchange rate.
- India follows a managed floating exchange rate system, where the rupee’s value is primarily determined by market forces of demand and supply.
- Demand for foreign currency arises from imports, foreign travel, capital outflows, and investments abroad, while supply comes from exports, remittances, and capital inflows.
- However, free market determination can lead to excessive volatility, especially during global shocks like wars, financial crises, or oil price spikes.
- To address this, the RBI intervenes in the forex market by buying or selling foreign currency using its reserves.
- Thus, RBI’s approach balances market determination with strategic intervention to maintain stability and investor confidence.
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