In its Article IV consultations with India released in December 2023, the International Monetary Fund reclassified India’s de facto exchange rate regime from “floating” to “stabilised arrangement”, while the de jure classification remained “floating”. The stabilised arrangement is a part of the broader category of a ‘soft peg’ exchange rate regime, which implies that a country’s central bank actively intervenes in the foreign exchange market to keep the value of the domestic currency within a narrow band with respect to a particular foreign currency. The IMF has argued that from December 2022 to October 2023, the rupee-US dollar exchange rate moved within a very narrow range, suggesting that India’s foreign exchange intervention has “likely exceeded levels necessary to address disorderly market conditions.”

According to the IMF Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) database, the other countries that are part of the stabilised arrangement with respect to the dollar are Cambodia, Guyana, Iran, Lebanon, Maldives, Trinidad and Tobago. Some other countries like Croatia, Bolivia, and Singapore are part of the same group but are based on different currencies or currency groups.

The IMF has the following rules for the classification of exchange rate regimes. It says: “Classification as a stabilised arrangement entails a spot market exchange rate that remains within a margin of 2 per cent for six months or more (with the exception of a specified number of outliers or step adjustments), and is not floating. … classification as a stabilised arrangement requires that the statistical criteria are met, and that the exchange rate remains stable as a result of official action (including structural market rigidities). The classification does not imply a policy commitment on the part of the country authorities.” It is notable that the IMF has used the rupee-dollar exchange rate for their classification purposes.

Statistical conditions

Therefore, there are two statistical conditions behind this reclassification. First, the rupee-dollar exchange rate movement should be within a band of 2 per cent for a period of six months or more. And, second, there must be some intervention in the foreign exchange market by the central bank. The extent of intervention has not been quantified in the requirements. It also suggests that there should be a causal relationship between the official action (like forex market intervention) and the stability of the exchange rate.

Not surprisingly, the IMF’s reclassification of India’s exchange rate regime has been countered by the Reserve Bank of India. The RBI argued that the time period of six to eight months is arbitrary, and if a longer-term view is taken, then India’s exchange rate regime will fulfil the requirements of a de facto and de jure floating exchange rate regime.

A look at the daily data of foreign exchange USD-INR rates reveals that the RBI has a valid point, and the conclusion by the IMF seems to be “cherry picking”, based on very selective observations. Chart 1 illustrates the rupee-dollar exchange rate movements for the one-year period from October 2022 to October 2023. As can be seen from the chart, the rupee has experienced significant volatility during the one-year period shown here. In fact, between December 2022 and October 2023, the rupee-dollar value has oscillated between 81.15 to 83.28 which is a 2.6 per per cent variation (Table 1).

But if we take a one year period from October 2022 to October 2023, the variation between the maximum and minimum values is more than 3.26 per cent. However, if one looks at the data for the six months period from May 2023 to October 2023, the variation in the exchange rate is about 1.88 per cent. It probably just about satisfies a necessary condition for the IMF to change the classification for India. Whether this warrants a change in India’s exchange rate regime is highly questionable.

It is also notable that in the last few years, the exchange rate volatility in emerging markets has been largely due to the sharp interest rate hikes in the US and the consequent capital outflows from India and other emerging markets. Since July 2023, however, the US Fed has kept the interest rate constant. Similarly, the RBI has not changed its repo rate since February 2023. Therefore, the nominal interest rate differential has remained steady during most of the period under the consideration of the IMF. As a result, there has been no pressure on the exchange rate from the nominal interest rate differential, which may dampen the INR-USD volatility of the INR-USD exchange rate.

Secondly, and on a related note, both the countries experienced a slowing down of inflation during this period. Both in the US and India, the inflation level moved closer to the target zones, thereby reducing expectations about interest rate changes in either country (Table 2), which may have again contributed to the stability of exchange rates.

Finally, let’s look at the foreign exchange intervention data by RBI in the OTC segment. We can see that the period of lower volatility of INR-USD exchange rate is also the period when forex intervention by RBI was low (Chart 2). During this entire period, operations by the RBI were predominantly in the OTC segment and Chart 2 highlights that RBI intervened much less in the forex market before October 2022 than after October 2022. Especially for the six months period prior to November 2023, average intervention by RBI is lower than the previous months as shown in Chart 2. This once again highlights that the relative stability of the exchange rate was due to macroeconomic factors and, therefore, it should not warrant a reclassification of India’s exchange rate regime.

Reclassification matters?

IMF’s reclassification of the exchange rate regime does not have any direct impact on India. There is, however, a possibility that certain countries can use this reclassification to argue that India implicitly provides support to its exporters. This may open up possibilities for remedial actions and sanctions against exports from India. In the past, the US Treasury department in their semi-annual reports titled ‘Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States’ have expressed apprehensions about exchange rate management of India.

Given the shortcomings of the IMF methodology, it will be unfair if the US Treasury report uses the IMF reclassification to question India’s exchange rate management policies. Instead, the clarification given by the RBI should be taken with all due seriousness.

Pal is Professor of Economics at IIM Calcutta, and Ray is Director, National Institute of Bank Management, Pune. Views are personal