The central bank may intervene in the market to influence the exchange rate or to reduce

volatility. The basic intention in such actions is to redefine the demand-supply equilibrium.

The central bank may transact in the market on its own for the above purpose or on behalf

of the government, when undertaking transactions which may involve foreign currency

payments and receipts. Under the Flexible Exchange Rate System currently in operation,

Central Banks are under no obligation to defend any particular exchange rate but still

intervene to change market sentiment.

The role of RBI in the exchange market is as follows :

 Monitoring and management of exchange rates without a pre-determined target rate

or range with intermittent intervention as and when necessary has been the basis of

the Managed Float system followed in India.

 A policy to build a higher level of foreign exchange reserves, which takes into

account not only anticipated current account deficits but also liquidity requirements

arising from unanticipated capital outflows.

 A judicious policy for management of capital account transactions, with progressive

liberalisation of such transactions.

 Balancing the external economy represented by the exchange rate and the internal

economy represented by interest rates, inflation, money supply, etc.


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