The rate of any currency traded on the Forex market is a variable value. It is influenced by various market and non-market factors. Today we will supplement this information and talk about what currency intervention is.
Currency intervention is one of the instruments of the national bank
The term intervention is most often used when we are talking about 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, almost all national banks widely use its capabilities in their monetary policy. What kind of instrument is this?
Foreign exchange intervention is a financial transaction carried out by a national bank or government agency charged with financial regulation. The purpose of such intervention is to influence exchange rate movements of the national currency.
For those who are not very well versed in the intricacies of economic formulations, let us explain what currency intervention is in simple words.
In fact, this is an ordinary financial transaction, as a result of which currency, which is an official means of payment in the country, is bought or sold. In Russia, such a currency is the ruble, in the United States – the dollar, in Japan – the yen, and so on.
The state entrusts the function of conducting such financial transactions to its central bank, and in some cases to the Ministry of Finance. These institutions are authorized to carry out currency regulation and influence the exchange rate of the state’s domestic currency.
To increase this exchange rate, a certain amount of national currency is purchased on the market for the currency of a foreign country. Since the volume of these purchases is significant, a shortage of currency withdrawn from the market arises, and its exchange rate rises. Selling your country’s currency, on the contrary, leads to the market becoming saturated with this currency, which means its exchange rate decreases.
For what problems does currency intervention have the maximum effect?
Currency intervention can influence exchange rate movements of the national currency. This fact is undeniable. But in this regard, a reasonable question arises: what problems can be solved using this tool?
The purpose of currency regulation carried out using foreign exchange intervention is the following:
- Maintaining the exchange rate within a certain price corridor. This approach to currency regulation is typical for countries with a fixed exchange rate.
- Elimination of negative trends that the exchange rate may have on the development of the state’s economy.
- Preventing significant deviations of the currency exchange rate from its equilibrium value. That is, the desire to ensure that the demand for currency and its supply are 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.
- Maintaining a level of liquidity of the national currency at which the volatility of its exchange rate will be minimal.
Who conducts currency interventions?
Typically, foreign exchange interventions are carried out by large banks, which are instructed by a national bank or body with appropriate powers to carry out a financial transaction. Such banks are authorized financial institutions to conduct foreign exchange interventions. They can carry out interventions:
- On the interbank foreign exchange market.
- On the Forex stock market.
- On the commodity market.
- On the currency exchange.
If the foreign exchange market cannot provide sufficient liquidity, then in this case foreign exchange interventions are carried out in the form of foreign exchange auctions.
The financial regulator independently selects a platform for conducting currency interventions. The Bank of Russia, for example, for such operations usually uses the trading platform of the Moscow Exchange, which, after merging with the MICEX, became the largest Russian exchange holding company. At the same time, it is necessary to pay attention to the fact that recently the currency intervention of the Central Bank of the Russian Federation has been carried out in a targeted manner; 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, currency interventions are usually divided into types. The main types of intervention are the following:
- Verbal. This type of intervention is inherently fictitious, since no actual purchase/sale of currency occurs. The country’s authorities declare their intention to make a one-time cash payment to purchase a large amount of currency, but at the same time they are holding a pause and are not entering the market. Typically, the foreign exchange market is sensitive to such information. This is what the bet is on. It is assumed that the majority of market participants will believe in the possibility of carrying out such a financial transaction and will follow the signal received, supporting the necessary trend in the development of the exchange rate of this currency.
- Real intervention. Currency intervention of this type does not imply any provocative actions or statements on the part of the country’s central bank or high-ranking government officials. The purchase/sale operation of the national currency is carried out in reality, as evidenced by the report, which indicates the specific amount of the intervention made.
Real mutual intervention. This is a joint, synchronously implemented agreement between the central banks of several countries, which undertake to simultaneously carry out foreign exchange intervention in their national market.
As practice shows, the effect of mutual intervention can be achieved more significantly than in the case of unilateral currency intervention. An example of such effectiveness was demonstrated by the agreement signed in 1985 in New York. The implementation of this agreement led to a drop in the value of the dollar by almost 50%.
- Typically, the benefit from mutual intervention is received by the country participating in the monetary union. The relationship between the countries included in such a union makes it possible to build a unified approach to ensuring stabilization of the exchange rate relative to third countries.
- Sterile and non-sterile intervention. Any central bank has obligations to creditors and issues cash. The totality of these financial resources constitutes the monetary base.
If a bank decides to buy national currency and spend foreign currency on it, then its gold and foreign exchange reserves decrease, as does the monetary base. The sale of national currency, on the contrary, leads to 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 unsterilized.
If a bank, while carrying out foreign exchange intervention, simultaneously carries out a financial operation on the domestic market, the result of which is the unchanged monetary base, then this will be considered a sterilized intervention.
Attitude of specialists to foreign exchange intervention
specialists working in the foreign exchange market believe that if the exchange rate is floating, then foreign exchange interventions lose their effectiveness. This point of view has the following justification:
- In modern market conditions, it is not possible to determine the equilibrium exchange rate, despite the presence of a large number of methods for determining it.
- Foreign exchange market volatility may be short-lived. Therefore, its presence should not always lead to the intervention of the national regulator in the operation of the foreign exchange market.
- In practice, currency intervention does not always lead to the desired result. In some cases, its use may cause increased volatility, which is undesirable for any central bank.