IMF warns financial shocks alone do not justify FX intervention

The International Monetary Fund (IMF) has cautioned that evidence of financial shocks in foreign exchange markets does not, on its own, justify central bank intervention, stressing the need for a broader assessment of market conditions and potential policy costs.

In a Staff Discussion Note titled Drivers of Exchange Rates in EMDEs: Implications for Foreign Exchange Intervention, the IMF outlines a framework to help policymakers distinguish exchange rate movements driven by macroeconomic fundamentals from those caused by financial shocks and market amplification.

The note argues that while exchange rate flexibility generally supports economic adjustment, market frictions can sometimes trigger destabilising currency movements, even when domestic fundamentals remain sound.

What the IMF is saying

The IMF’s framework uses monthly macrofinancial data, theoretical models and evidence from real-world episodes to assess the drivers of exchange rate movements in emerging market and developing economies (EMDEs).

Applied to Brazil and Chile, the analysis found that financial shocks account for about a third of uncovered interest parity (UIP) fluctuations on average.

• The IMF said this suggests that “most of the time, exchange rate movements reflect forces that may not require any policy action.”
• “The financial shock plays a sizably more prevalent role in driving UIP and exchange rate fluctuations, as opposed to output and inflation. It accounts for approximately one-third of the variance of the UIP premium and about one-half of nominal exchange rate fluctuations. In contrast, it accounts for less than 10 percent of macroeconomic aggregates such as output and inflation,” the organisation noted.

However, the note highlights that financial frictions can amplify shocks and transmit them to the real economy. Episodes of sharp increases in financial stress were associated with notable declines in output, underscoring the importance of monitoring market-functioning indicators.

The framework is intended to help policymakers assess exchange rate movements in real time and determine whether circumstances may warrant intervention under the IMF’s Integrated Policy Framework (IPF).

• The IMF cautioned that identifying a financial shock may indicate that intervention could be relevant, but it is “neither necessary nor sufficient by itself to justify the use of FXI.”
• The note explains that foreign exchange intervention (FXI) may be warranted in other circumstances, including currency mismatches or unanchored inflation expectations, even when financial shocks are absent.

Where intervention is being considered to stabilise exchange rate risk premia, the presence of a financial shock is still not sufficient on its own. Policymakers must assess a wider range of factors, including the adequacy of foreign exchange reserves, the expected effectiveness of intervention compared with alternatives such as macroprudential policies.

• The IMF noted that reserve adequacy varies considerably across countries, with some holding substantial buffers while others have limited capacity to absorb shocks.

This, it said, reinforces the need for a careful cost-benefit assessment before intervening in foreign exchange markets.

• For countries operating floating exchange rate regimes, the Fund added, “maintaining exchange rate flexibility remains crucial for facilitating adjustments to shocks and supporting macroeconomic stability.”

Get up to speed

The IMF’s findings come amid changes in Nigeria’s foreign exchange market, including renewed foreign investor interest and rising external reserves.

• In May, the Governor of the Central Bank of Nigeria (CBN), Olayemi Cardoso, dismissed claims that the apex bank was aggressively intervening to defend the naira. He said the CBN’s interventions accounted for about 1.2% to 1.3% of total FX turnover.
• President Bola Tinubu appointed Cardoso as CBN governor in 2023, and the government set out to implement a series of monetary and fiscal policies reforms, including floating the Naira and initiating tight monetary policy to combat inflation and exchange rate volatility.
• Nigeria’s gross foreign exchange reserves rose to $54.61 billion by mid-September 2026, supported by improved external liquidity and portfolio inflows.
• The country also attracted $10.37 billion in foreign capital in the first quarter of 2026, an 83.8% increase from the $5.64 billion recorded in the corresponding period of 2025.
• The banking sector received $7.55 billion, accounting for 72.8% of total capital imported during the quarter, while the financing sector attracted $2.43 billion.
• Portfolio-related inflows were particularly pronounced in January, when foreign portfolio investment reached $3.37 billion, representing 95.72% of total capital importation for the month.

Nigeria was also recently included in J.P. Morgan’s newly introduced Government Bond Index–Emerging Markets Edge (GBI-EM Edge), with a 7.4% weighting in the benchmark tracking local-currency government debt across frontier emerging markets.

What you should know

Nairametrics earlier reported that Nigeria’s external reserves have grown by $7.09 billion since the beginning of 2026.

The latest position has now surpassed the CBN’s projected reserve level of approximately $51.04 billion for the whole of 2026.

The continued accumulation of reserves provides a stronger external buffer for the Nigerian economy and comes as the CBN continues efforts to strengthen foreign exchange market stability.

Also, the latest increase in external reserves comes as the CBN maintains a tight monetary policy stance aimed at moderating inflation and supporting macroeconomic stability.