Fund says currency movements require broader assessment, including reserves, policy alternatives and potential economic costs….
The International Monetary Fund has warned central banks against treating evidence of financial shocks in foreign exchange markets as an automatic trigger for intervention, saying policymakers must first assess the wider economic implications and possible costs of such action.
The warning is contained in a new IMF Staff Discussion Note titled Drivers of Exchange Rates in EMDEs: Implications for Foreign Exchange Intervention, which examines how exchange rate movements in emerging market and developing economies are shaped by economic fundamentals, financial shocks and market frictions.
According to the Fund, exchange rate flexibility generally helps economies adjust to changing conditions. However, disruptions in financial markets can sometimes magnify currency movements and create instability, even when a country’s underlying economic fundamentals remain relatively sound.
The IMF developed a framework using monthly macrofinancial data, theoretical models and evidence from actual market episodes to help policymakers identify the forces behind exchange rate movements and determine when foreign exchange intervention may be appropriate.
Its analysis of Brazil and Chile found that financial shocks accounted, on average, for about one-third of fluctuations in uncovered interest parity, a measure used to assess differences between interest rates and expected exchange rate movements.
The Fund said the finding indicates that exchange rate movements do not necessarily require a policy response in most circumstances.
“The financial shock plays a sizably more prevalent role in driving UIP and exchange rate fluctuations, as opposed to output and inflation,” the IMF said.
It added that financial shocks accounted for approximately one-third of the variance in the UIP premium and about half of nominal exchange rate fluctuations, compared with less than 10 per cent of changes in major macroeconomic indicators such as output and inflation.
However, the IMF noted that the consequences can become more significant when financial market frictions amplify shocks and transmit them into the wider economy.
According to the Fund, periods of heightened financial stress have been associated with significant declines in economic output, making indicators of market functioning an important part of policymakers’ assessment.
The framework is intended to help authorities evaluate exchange rate pressures in real time and determine whether intervention may be appropriate under the IMF’s Integrated Policy Framework.
But the Fund stressed that identifying a financial shock does not, by itself, provide sufficient grounds for foreign exchange intervention.
“Neither necessary nor sufficient by itself to justify the use of FXI,” the IMF said, referring to the presence of a financial shock as a consideration for intervention.
The Fund explained that intervention could still be justified in circumstances where financial shocks are not evident, including situations involving currency mismatches or inflation expectations that have become unanchored.
Where authorities are considering intervention to contain exchange rate risk premiums, the IMF said they must also examine other factors before taking action.
These include the level of foreign exchange reserves available to the central bank, the likely effectiveness of intervention and whether alternative measures, including macroprudential policies, could achieve the desired outcome at a lower cost.
The IMF noted that reserve positions differ substantially across countries, with some economies maintaining sizeable buffers while others have limited capacity to absorb external shocks.
This, it said, makes a careful cost-benefit assessment essential before authorities intervene in the foreign exchange market.
For countries operating under floating exchange rate regimes, the Fund maintained that allowing currencies to adjust remains important for absorbing external shocks and supporting broader macroeconomic stability.
The IMF’s assessment comes as Nigeria’s foreign exchange market records increased investor activity alongside a rise in the country’s external reserves.
Central Bank of Nigeria Governor Olayemi Cardoso said in May that the apex bank was not aggressively intervening to defend the naira, putting CBN intervention at about 1.2 per cent to 1.3 per cent of total foreign exchange turnover.
Since Cardoso assumed office in 2023, the Federal Government and the CBN have pursued a series of monetary and fiscal reforms, including changes to the foreign exchange market and tighter monetary conditions aimed at addressing inflation and exchange rate pressures.
Nigeria’s gross foreign exchange reserves climbed to $54.61 billion by mid-September 2026, supported by stronger external liquidity and portfolio inflows.
The country also recorded $10.37 billion in foreign capital inflows in the first quarter of 2026, representing an 83.8 per cent increase from the $5.64 billion recorded during the same period in 2025.
The banking sector accounted for the largest share of the inflows, receiving $7.55 billion, or 72.8 per cent of total capital imported during the quarter. The financing sector attracted a further $2.43 billion.
Portfolio investment also recorded strong activity, particularly in January, when foreign portfolio investment reached $3.37 billion, accounting for 95.72 per cent of total capital importation for the month.
Nigeria has also recently been added to J.P. Morgan’s newly introduced Government Bond Index–Emerging Markets Edge, with the country assigned a 7.4 per cent weighting in the benchmark tracking local-currency government debt across frontier emerging markets.
The increase in reserves has added to Nigeria’s external buffers, with the latest figure representing a $7.09 billion increase from the beginning of 2026.
The reserve position has also moved above the CBN’s earlier projection of about $51.04 billion for the end of 2026.
The stronger reserve position comes as the apex bank maintains a tight monetary policy stance aimed at containing inflation and supporting macroeconomic stability.
Against this backdrop, the IMF’s latest guidance places emphasis on assessing the source and wider effects of exchange rate pressures before deploying foreign exchange intervention, rather than treating every financial shock as a sufficient reason for central bank action.
