CBO has an important role to play in the foreign exchange market in the operation of the pegged exchange rate regime and its sustainability. While the Government sells foreign exchange to the CBO to meet its RO needs, the banks approach the CBO for their day-to-day requirements of foreign exchange mainly to meet their customer demands. In order to defend the currency peg effectively, the CBO has to ensure that it has an adequate amount of foreign exchange reserves to meet any emerging liquidity needs in the system.
The demand for foreign exchange in the local foreign exchange market is mainly fuelled by the import demand in the economy. The speculative demand for forex is contained to some extent by restrictions imposed on banks’ open position limits .