The Reserve Bank of India has a sophisticated toolkit, quite apart from interest rates, to intervene in both domestic liquidity and forex markets
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Supatman
There has been an animated debate on whether the Monetary Policy Committee (MPC) should hike the policy repo rate later this week. Those who feel rates should be hiked have cited incipient inflation and the depreciating rupee as reasons. Here, it is important to cite a monetary policy maxim — that using interest rates to target both domestic and external parameters is generally considered to be a bad idea.
The Reserve Bank of India has a sophisticated toolkit, quite apart from interest rates, to intervene in both domestic liquidity and forex markets — which ensures that neither is roiled in the process. The use of interest rate to manage the rupee can send contrary confidence signals. Therefore, interest rate moves should be pegged more to domestic conditions. All things considered, a status quo this time seems the best course of action. These are exceptional, war-torn times. Like the rest of the world, India is faced with a difficult year ahead. Global commodity, currency and financial markets are very volatile, as a result of which India’s growth inflation-mix has altered rapidly since the April monetary policy. Growth prospects are likely to have receded by about 30 basis points for FY27 since April, from 6.9 per cent to 6.6 per cent, on supply bottlenecks.
Inflation is likely to be closer to 5 per cent in FY27, up 40 basis points — with crude prices assumed to be at an average $95 a barrel. RBI, an inflation-targeting central bank, is up against a dual growth and inflation challenge. With wholesale price inflation at a 42-month high of 8.3 per cent in April, RBI Governor Sanjay Malhotra has said that inflation could get generalised — despite retail inflation being at 3.5 per cent in April, which is within the 2-6 per cent target. In that event, RBI Governor has indicated future hikes. For now, there is breathing space, precisely because the mandate is one of ‘flexible’ inflation targeting, which allows growth concerns a look-in. There is a window to allow growth, given the prospect of a weak monsoon.
The RBI seems to be cognisant of this fact. The system has been in liquidity surplus, despite heavy interventions in the forex market in recent days. The way forward should be to keep the policy rate at 5.25 per cent at least till the real interest rate does not slip deep into negative, and till such time address inflation through subtle liquidity management, which could include ‘operation twist’ which flattens the yield curve. Another option before the MPC is to raise the marginal standing facility rate — the emergency overnight lending window for banks, which is rarely used. If liquidity can be subtly managed without changing the policy rate, the rupee can be dealt with without creating a flutter. Buy-sell rupee-dollar swaps can arrest depreciation such that the liquidity or forex impact is deferred. Finally, if headline inflation were to spin out of control, there is always the option of doing an off-cycle rate hike. So, it is best to stay the course now.
Published on May 31, 2026
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