Sterilisation

Reviewed by Anjaneyulu | Updated on Sep 28, 2020

Introduction

In macroeconomics, sterilisation is an action taken by the central bank of a nation to counter the effects on the money supply triggered by a balance of payments surplus or deficit. This may include open market operations conducted by the central bank aimed at neutralising the impact of the foreign exchange operations associated with it. The reverse is an unsterilised intervention, where monetary authorities are involved.

Understanding Sterilisation

Sterilisation is commonly used in a central bank that takes action to negate potentially harmful impacts of capital inflows, such as currency appreciation and inflation, which can both reduce competitiveness in exports.

More broadly, it may refer to any form of monetary policy that seeks to keep the domestic money supply unchanged despite external shocks or other changes, including capital flows out of the relevant area (usually, a country).

In the second half of the 20th century, sterilisation was sometimes correlated with monetary authorities' attempts to "defend" their currency's value. Sterilisation was most commonly associated in the 1930s and the 21st century with efforts by nations with a surplus balance of payments to avoid currency appreciation.

Sterilisation in India

In India, the sterilisation coefficient (SC) is negative in sign, lying between -1 and 0. If it is equal to -1, it implies that the increase in net foreign exchange assets resulting from intervention in the foreign exchange market was offset by an inverse shift in net domestic assets, meaning that the initial intervention was fully sterilised.

Under perfect capital mobility and fixed exchange rates, this coefficient assumes a value of -1, as any expansion of the central bank's foreign currency assets (NFA) will lead to an offsetting change in net domestic assets (NDA), leaving the money stock unchanged and implying a virtual loss of monetary autonomy.

Many researchers have calculated the "sterilisation coefficient" by using different methodologies over different periods. RBI's most recent study (Raj, Pattanaik, Bhattacharya and Abhilasha, 2018) estimated a sterilisation coefficient of –1.03, using monthly data over a period of 20 years from July 1997 to October 2017, consistent with Ouyang and Rajan's findings (2008).

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