Should RBI support the currency at all? Instead of letting it float freely, the central bank intervenes now and then in the forex market to dampen volatility (its stated aim). But as a dollar focus often hardens the rupee against other currencies and prices Indian exports out of non-US markets, critics would rather let it slide for us to gain competitiveness. In any case, under pressure, it can’t be propped up for too long without a jerky drop later on. While all this is true, such advice runs up against the exigency of an inflation flare-up. Fuel is a big chunk of our imports and demand for it lacks price elasticity, not just because it’s an essential, but also on account of state controls that insulate local prices from global reality, with the result that global crude spikes typically fan local inflation up and leave us in a scramble for dollars. As reform attempts in this sector have failed and our trade dynamics remain too rigid overall for rate fluctuations to adjust the trade scales, a weak rupee hurts more than it otherwise would. Its value being driven more by capital flows and global liquidity conditions often amplifies that effect. It’s a peculiarity makes a special case for a currency float moderated by the specific scenario that prevails. If price stability is the big urgency, for example, an extended rupee prop could indeed be of help.
Our globalization context is also unique for residual capital curbs. Large sums of money cannot freely be sent overseas. This makes it tricky for RBI to grapple with the so-called ‘impossible trinity’, by which we can have only two of the following three: open capital flows, monetary policy freedom and exchange rate control. Market economies usually let capital move in and out without barriers, ask their central banks to manage the internal price of money (and what it buys at the retail level), but leave their currency’s exchange rate alone. In contrast, India’s calibrated setting for the first knob has meant that while the second is RBI’s basic job, we also try turning the third knob in volatile times. Success has never been easy. A variety of variables and situations demand vigil and spot analysis. This can be very taxing. But, given the tough set of challenges we face right now, RBI has little choice but to feel its way forward with rupee management.
