Central bank intervention in currency markets has picked up considerable pace in the last one month. The SNB (Swiss National Bank) started off the process by selling Euros at CHF (Swiss Franc) 1.20 levels. The CHF had appreciated by over 15% against the Euro in the June-August 2011 period before the SNB started making noises on the CHF strength. The markets continued to take up the CHF forcing the SNB to start intervening aggressively to protect the CHF 1.2 levels. The markets will continue to test the resolve of the SNB in protecting the Euro.
The RBI intervened in the currency markets to prevent a sharp slide in the INR (Indian Rupee) against the USD (US Dollar). The INR lost almost 10% to the USD in about a couple of months and markets were pushing it down further when the RBI came in and sold USD at Rs 48 levels. The amount of intervention was low but it helped calm jittery markets, which saw large scale selling of the INR on global risk aversion fears.
The ECB (European Central Bank) is lending USD to banks in need of USD liquidity. The ECB is lending USD for three months to USD liquidity strapped banks as the markets are shunning from giving them liquidity due to worries on the banks exposure to debt of Greece and other highly indebted countries. The Euro had lost over 4% against the USD on worries of sovereign debt in the Eurozone.
The Bank of Korea was seen selling USD at around KRW (Korean Won) 1120 levels to prevent the currency from sliding further against the USD. The KRW had tanked by over 6% against the USD in the last couple of months to touch a six month low. The fall in KRW was due to selling by overseas investors and traders on the back of global risk aversion.
The movements in currencies are causing sleepless nights for central banks. The volatility is excessive and central banks are forced to intervene to clam the markets or protect a level. The question is has currency fundamentals changed in the very short term to cause such volatility? If the fundamentals have changed, central bank intervention will only temporarily stem the tide. Prolonged intervention can only cause depletion of reserves if the stronger currency is sold or liquidity and inflation if the weaker currency is bought. If the fundamentals have not changed and currency volatility is caused by speculation central bank intervention can help in containing speculative volatility.
The fundamentals have changed for Eurozone countries. There is a real threat of default by Greece with two year bond yields touching 60% and there is the risk of the default contagion spreading to Portugal, Ireland and Italy. The real issue is when debt mature’s, the countries should be able to refinance the debt. If the markets are not willing to lend to these indebted countries or ask for a much higher rate to refinance the debt, the countries go into further trouble. Banks exposed to Eurozone sovereign debt do not have the liquidity nor the appetite to subscribe to more debt and are more than wiling to let matured debt not be replaced.
Countries such as India and Korea have a different problem. The problem is of volatility and risk aversion. A weak currency hurts the cost of servicing external debt while central bank intervention to protect the currency drains out liquidity from the system, hurting rates and credit growth. In the longer run, the currencies of India and Korea will find their own equilibrium and if its neither too strong nor too weak it will actually benefit the economies.