Rupee and the RBI: No more abstaining? – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-editorial/rupee-and-the-rbi-no-more-abstaining/articleshow/90060863.cms

Synopsis

Crude oil is now way above the price range factored in by the Indian government for the next financial year, and once it allows a pass-through, the effect on ailing consumption demand ought to show up. With central banks beginning their interest rate hike cycle, the flight of portfolio investment is adding to the pressure of a bloated oil import bill.

The rupee sank 1% on Monday, after falling 1.15% the previous week, as surging oil prices on account of the Russia-Ukraine hostilities threatened to widen India’s current account and fiscal deficits. With the rupee approaching 77 to a dollar, it has declined the most this year among currencies of Asia’s energy-importing countries as inflation – already above the upper threshold of the policy band – could become persistent. Crude oil is now way above the price range factored in by the Indian government for the next financial year, and once it allows a pass-through, the effect on ailing consumption demand ought to show up. With central banks beginning their interest rate hike cycle, the flight of portfolio investment is adding to the pressure of a bloated oil import bill.

In February, the Reserve Bank of India (RBI) had retained its accommodative monetary stance to nurse economic recovery through a big government borrowing programme. The picture has changed dramatically since then, and India now has to deal with twin deficits: of fiscal as well as trade. The RBI is intervening in both the bond and forex markets to nudge up interest rates and cushion the rupee’s fall. These, however, are in the nature of routine liquidity management and spot foreign exchange interventions. Significant damage to the current account or fiscal positions would require more vigorous intervention by the central bank and could hasten its rate-tightening cycle.

The oil shock will bring to the fore the economic policy trilemma of managing interest and exchange rates in a turbulent capital market. The managed float of the rupee has traditionally had a depreciating bias, and the RBI now has more reserves to stabilise the rupee. The current bout of volatility can be used for the benefit of Indian exporters. The European conflict is likely to disrupt merchandise trade more than the trade in services, where India has the traditional advantage. The RBI may have a bigger runway than what the current bout of volatility in financial markets would suggest.

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