Harish Damodran writes “The question remains: Why has the RBI not jacked up interest rates this time, unlike in 2013? The reason is that in the last currency crisis episode, India was also facing near double-digit inflation. Annual consumer price index (CPI) inflation in July 2013 and August 2013 was 9.79 per cent and 9.98 per cent, respectively. The central bank had every reason, then, to raise interest rates, irrespective of whether or not the rupee was weakening. By comparison, the latest CPI inflation rate readings for August and September 2018 are just 3.69 % and 3.77 %”
That dilemma is, perhaps, far less today where the RBI is primarily an inflation-targeting central bank. When CPI inflation is running well below its target of 4 per cent, why should it raise interest rates? Even when it comes to the rupee, it needs to be borne in mind that the latter’s trade-weighted “real effective exchange rate” — which is against a basket of 36 currencies and adjusted for underlying inflation differentials vis a vis the countries concerned — appreciated by 16.6 per cent between April 2014 and December 2017. It has depreciated by 8.7 per cent till September, but the rupee is still stronger by 6.5 per cent in real effective terms from the time of the Modi government assuming office.
He concludes “Yes, the RBI should intervene to ensure no undue volatility in the rupee, including by selling dollars from its reserves, so that speculators don’t mount one-way bets or exporters delay bringing in their earnings. But that is different from steeply hiking interest rates for firms and households. A long overdue correction in the rupee will ultimately help Indian industry, farmers and other small producers. No central bank or sovereign should be obliged to bond vigilantes, leave alone allowing them to make a killing even on exiting their investments.”