What is foreign exchange intervention?
The exchange rate of any currency traded on the Forex market is variable. It is influenced by various market and non-commercial factors. You can read more about this at tradernew.pro. Today we will complement this information and talk about what monetary intervention is.
- The exchange intervention as one of the instruments of the national banking system.
- For the solution of what tasks does foreign exchange intervention give the maximum effect?
- Who performs the foreign exchange interventions?
- Types of foreign exchange intervention.
- The attitude of the specialists before the foreign exchange intervention.
Foreign exchange intervention is one of the instruments of the national bank
The term intervention is most often used when it comes to the intervention of one or a group of states in the affairs of another state. This practice is not welcomed by the international community and is prohibited. But this prohibition does not apply to foreign exchange intervention. On the contrary, practically all national banks take full advantage of their opportunities in their monetary policy. What is this instrument?
A foreign exchange intervention is a financial transaction carried out by a national bank or a government agency in charge of financial regulation. The purpose of such intervention is to influence the movements of the exchange rate of the national currency.
For those who are not well versed in the intricacies of economic formulations, let us explain what monetary intervention is in simple terms.
In fact, this is an ordinary financial transaction, as a result of which currency is bought or sold, which is legal tender on the territory of the country. In Russia, that currency is the ruble, in the United States, the dollar, Japan, the yen, etc.
The state assigns the function of carrying out such financial transactions to its central bank and, in some cases, to the ministry of finance. These institutions are authorized to carry out exchange regulation and influence the rate of the state’s internal currency.
To increase this rate, a certain amount of national currency is bought on the market for the currency of a foreign state. Since the volume of these purchases is significant, there is a deficit of the currency withdrawn from the market and its rate is growing. Selling the country’s own currency, on the contrary, leads to the market being saturated with this currency, which means that its rate decreases.
For the solution of what tasks does foreign exchange intervention give the maximum effect?
Foreign exchange intervention is capable of influencing the movements of the exchange rate of the national currency. This fact is undeniable. But in this regard, a reasonable question arises, what tasks can be solved with this tool?
The purpose of foreign exchange regulation carried out through foreign exchange intervention is as follows:
- Maintain the exchange rate within a certain price band. This approach to foreign exchange regulation is typical of countries whose exchange rates are fixed.
- Elimination of negative trends that the exchange rate may have on the development of the state economy.
- Prevention of significant deviations of the exchange rate from its equilibrium value. That is, the desire to ensure that the demand for the currency and its supply were balanced.
- Replenishment of the country’s gold and foreign exchange reserves, which is achieved as a result of the sale of national currency and the purchase of foreign currency.
- Maintain such a level of liquidity of the national currency in which the volatility of its exchange rate will be minimal.
Who performs the foreign exchange interventions?
Foreign exchange interventions are usually carried out by large banks, which receive instructions from the national bank or a body with the appropriate authority to carry out a financial transaction. These banks are financial institutions authorized to carry out foreign exchange interventions. They can intervene:
- In the interbank foreign exchange market.
- In the Forex stock market.
- In the raw materials market.
- About the currency exchange.
If the foreign exchange market cannot provide sufficient liquidity, foreign exchange interventions are carried out in the form of foreign exchange auctions.
The financial regulator independently chooses a platform to carry out foreign exchange interventions. The Bank of Russia, for example, for such operations generally uses the trading floor of the Moscow Stock Exchange, which, after the merger with MICEX, became the largest securities holding company in Russia. At the same time, it is necessary to pay attention to the fact that in recent years the foreign exchange intervention of the Central Bank of the Russian Federation has been carried out on a one-off basis, large-scale interventions have not been observed. This happened after the ruble exchange rate became floating.
Types of foreign exchange intervention
Depending on the methods of practical application, it is customary to divide foreign exchange interventions into types. The main types of intervention are the following:
- Verbal. This type of intervention is inherently fictitious, as the actual buying/selling of currency does not take place. The country’s authorities declare their intention to make a one-time cash payment for the purchase of a large amount of currency, but at the same time they pause and do not enter the market. In general, the foreign exchange market is sensitive to such information. This is what you bet on. It is assumed that the majority of market participants will believe in the possibility of such a financial operation, will follow the received signal, supporting the necessary trend in the development of the rate of this currency.
- actual intervention. Foreign exchange intervention of this type does not imply provocative actions or statements by the country’s central bank or high-ranking government officials. The purchase / sale operation of national currency is carried out in reality, as evidenced by the report, which indicates the specific amount of the intervention.
- Real mutual intervention. It is a joint agreement, implemented synchronously between the central banks of several countries, which assume the obligation to simultaneously carry out foreign exchange intervention in their national market.
As practice shows, the effect of mutual intervention can be achieved more significant than in the case where unilateral foreign exchange intervention is carried out. An example of this efficiency was demonstrated by the agreement signed in 1985 in New York. The implementation of this agreement caused a drop in the dollar rate by almost 50%.
Normally, a member country of a monetary union benefits from mutual intervention. The relationship between the countries that make up this alliance allows the construction of a unified approach to ensure the stabilization of the exchange rate with respect to third countries.
- Sterile and non-sterile intervention. Any central bank has obligations to creditors and issues cash in circulation. The totality of these financial resources constitutes the monetary base.
If the bank decides to buy the domestic currency and spend foreign currency on it, then its gold and foreign currency reserves decrease, just as the monetary base decreases. The sale of the national currency, on the other hand, entails an increase in the gold and foreign exchange reserves and an increase in the monetary base. Therefore, it is generally accepted that foreign exchange intervention affecting the monetary base is not sterilized.
If a bank, when carrying out a foreign exchange intervention, simultaneously carries out a financial transaction in the domestic market, the result of which is the invariability of the monetary base, then this will be considered a sterilized intervention.
The attitude of specialists towards foreign exchange intervention
specialists working in the foreign exchange market believe that if the exchange rate is floating, foreign exchange interventions lose their effectiveness. This point of view has the following foundation:
- In modern market conditions, it is not possible to determine the equilibrium exchange rate, despite the presence of a large number of methods for its determination.
- Forex market volatility can be short-lived. Therefore, their presence should not always lead to the interference of the national regulator in the work of the foreign exchange market.
- In practice, foreign exchange intervention does not always lead to the desired result. In some cases, its application can cause an increase in volatility, which is not desirable for any central bank.
Useful information on what is the liquidity of a commercial bank at the link.
Answers to popular questions about foreign exchange intervention
What is foreign exchange intervention? Foreign exchange intervention is a financial operation carried out by the state (national bank or ministry of finance) as a result of which the national currency is bought or sold in large volumes at the expense of foreign currency. Thus, the exchange rate of the national currency rises or falls due to the increase or underestimation of demand. This operation is most often carried out to stabilize the currency. Why is foreign exchange intervention taking place? Monetary intervention is a mechanism that allows regulating the exchange rate of the national currency, increasing its value, or vice versa, decreasing it.This measure is very actively used during the crisis in the state currency exchange, but only in the case of a high level of gold and foreign exchange reserves of the national bank. How does monetary intervention work?The foreign exchange intervention process is quite simple. The state, in the form of a national bank, uses its gold and foreign exchange reserves, buying its own currency from it. Thus, the demand for the national currency is increasing and, consequently, the value of the national currency is growing. To reduce the exchange rate of the national currency, a reverse purchase and sale operation is carried out. Foreign exchange intervention is beneficial for importers, citizens of the country and financial institutions. The only class “affected” by foreign exchange intervention are exporters.Who benefits from foreign exchange intervention?But since this financial instrument in the modern world is used exclusively during a crisis and to stabilize the national currency, this procedure is beneficial to everyone. Is foreign exchange intervention always successful? The success of a foreign exchange intervention depends on several factors, the first is the ability of this instrument to cover other factors of the fall of the national currency. In the case of macrostabilization, intervention is the most effective financial instrument to maintain its own currency.In the case of high inflation, foreign exchange intervention is ineffective and only slows down the irreversible process.