The rupee is plumbing fresh lows despite the Reserve Bank of India (RBI) dipping into foreign exchange reserves to slow the descent. This was an expected fallout of capital flight, combined with the trade shock to an energy-importing country like India. How long the RBI proceeds on this course of action will depend on India's assessment of the prospects of conflict de-escalation, which are not very promising. Capital flight will impose a separate conditionality on the pace of interest-rate hikes. Last week, the RBI acted out of turn to manage the interest-rate differential with the US Federal Reserve. India has, over the course of a few weeks, lost considerable leeway in managing its interest and foreign exchange rates.
There are two textbook prescriptions in such situations. The first is to allow the rupee to find its level. Tightening monetary policy will temper inflation, slow growth and thus imports, pulling back trade into balance. The second approach is to push the exchange rate lower, advantaging exports and disadvantaging imports to bring trade into balance without inordinately compressing domestic output. This could also be achieved by letting the rupee find its own level. The two sets of interventions are self-reinforcing, although one uses monetary contraction while the other is expansionary.
India's policy response will most likely be somewhere in the middle, with interest-rate tightening slower than in the US and a managed depreciation of the rupee. Economic activity has not yet recovered to pre-pandemic levels and the scope of substituting energy imports is limited. There are also questions over whether a weakening rupee can aid merchandise exports in a slowing global economy. Especially if competing nations allow their currencies to depreciate more. India has a cushion in technology
Source Name:-Economic Times