Understand the basics behind RBI’s moves.

The Reserve Bank of India’s (RBI) objective is to foster growth and manage inflationary expectations. Although it may sound easy, maintaining a fine balance between the impossible trinity or ‘trilemma’ of inflation, exchange rate and foreign flows is quite a task. At any point in time, volatility and fluctuations in one of these key elements make it difficult for the central bank to achieve its dual objective. Therefore, let us try to understand what the central bank might do on Tuesday by considering these three variables in different ways.

Forex Rate

Foreign exchange (forex) rate is a tricky game. A quick turnaround in the economy and promising growth prospects make India an attractive destination for foreign investors. Going forward, we expect the economy to attract larger chuck of investments by foreign investors. Large inflow of foreign funds appreciates the Indian rupee, which in turn spells disaster for the country’s export sector. Recently, as the rupee touched the 19-month high figure, RBI intervened and supported the domestic currency from appreciating further. The central bank announced intentions of issuing bonds worth Rs 5,000 crore through Market Stabilisation Scheme (MSS). However, there is a limited role that RBI can play and therefore, the use of rupee to control inflation seems unlikely.

Source : indianexpress.com