Can fear of currency appreciation gear up reserve accretion?

Abstract

This paper investigates whether the Reserve Bank of India's intervention in the foreign exchange market has preference asymmetry and also attempts to find out whether reserve accumulation is significantly an outcome of such an asymmetric intervention. In this regard, we construct quarterly models of reserve demand wherein shocks to rupee appreciation and depreciation with their pace are included to capture the asymmetry in intervention, apart from incorporating certain key control variables as determinants. The econometric estimates obtained from the autoregressive distributed lag model confirm that intervention reflects asymmetric preference; the authority seems to tame rupee appreciation more aggressively than rupee depreciation of the same magnitude. Moreover, the reaction to pace of rupee appreciation is found to be much stronger than to pace of rupee depreciation; thus, providing additional support for the asymmetry in intervention. Further, the empirical results are subjected to robustness check and the evidence remains robust to an alternative definition of reserves. The overall evidence, thus, suggests that there is a fear of currency appreciation, which appears to be one of the important factors behind the large stockpile of reserves in India.