How Central Banks Defend Currencies Under Pressure

In the world of economics, a currency crisis is fundamentally a confidence crisis. When faith in an economy weakens, capital flees, exchange rates spiral, and currencies decline sharply. This is why central banks worldwide step in to arrest such declines, not merely to defend exchange rates, but to restore confidence.

Modern central banking increasingly embraces the "whatever it takes" doctrine, first articulated by Mario Draghi during the eurozone crisis in 2012.

The Draghi Moment: When Words Saved a Currency

At the peak of the euro crisis in 2012, the eurozone was on the brink of collapse. Investors were openly betting on a breakup of the single currency. Sovereign bond yields in Greece, Spain, and Italy were spiralling, and massive capital flight was underway.

Speaking at a London conference, Draghi delivered what would become the most consequential central bank statement of the modern era:

"Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough."

Markets stabilised almost instantly. Bond yields fell, the euro recovered and speculative bets against the currency unwound without the ECB spending a single euro. The power lay in the credibility of the institution behind the statement.

Japan's Direct Intervention Strategy

Japan provides one of the most visible examples of direct foreign exchange intervention. In 2024, as the yen slid to a 38-year low of around 162 to the dollar, Japanese authorities stepped in forcefully.

The Bank of Japan, alongside the Ministry of Finance, sold dollars and bought yen directly in the market, spending tens of billions from foreign exchange reserves. The intervention triggered a sharp yen rebound, though the impact proved temporary.

Japan's motivation was clear: rapid yen weakening was fuelling imported inflation, raising energy costs and eroding household purchasing power.

Britain's Unconventional Response

In 2022, the UK faced its own currency shock following the government's unfunded "mini-budget," which proposed nearly $45 billion in tax cuts. Markets lost confidence in Britain's fiscal credibility, and the pound crashed to a record low against the dollar.

The Bank of England intervened not primarily through foreign exchange markets, but by launching emergency bond-buying operations to stabilise the gilt market. By restoring order in the bond market and signalling policy credibility, the BoE indirectly stabilised the pound.

China's Controlled Approach

China offers a different model entirely. The People's Bank of China does not allow its currency to freely float, instead managing the yuan through a daily fixing mechanism.

When depreciation pressures intensify, Chinese authorities typically act through state-owned banks, which sell dollars and buy yuan in both onshore and offshore markets. Capital controls are tightened, liquidity conditions adjusted, and messaging carefully calibrated.

India's Measured Response

This global context becomes relevant as the Indian rupee continues weakening, recently crossing the 92-per-dollar mark. The Reserve Bank of India does not defend a specific exchange rate, instead intervening only to smooth excessive volatility.

RBI's framework allows the rupee to adjust to global forces such as dollar strength, oil prices, and capital flows, intervening only when moves become disorderly. India enjoys strong buffers: ample forex reserves, manageable external debt, and relatively stable capital flows.

Unlike crisis-hit economies, the rupee's decline reflects global dollar strength rather than domestic macroeconomic stress, illustrating the varied approaches central banks take when defending their currencies under pressure.