Policy process: Currency-market intervention should be more selective

Indian financial markets have been speculating about when the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) will start cutting policy rates, particularly since the US Federal Reserve decided to reduce its policy rate by 50 basis points. The MPC meeting with three new external members earlier this month left the policy repo rate unchanged at 6.5 per cent.

The committee, however, changed its stance to “neutral” from “withdrawal of accommodation” to give itself more flexibility in an increasingly uncertain global economic environment. Although RBI Governor Shaktikanta Das well explained the reasons for the MPC’s decision and stance after the MPC meeting, he further elaborated on the central bank’s position on monetary policy and other matters in an event last week. They are worth discussing here.
 

On monetary policy, Mr Das categorically noted that a rate cut would be premature and could be “very, very risky”. The consumer price index-based inflation rate came at 5.5 per cent for September, largely driven by higher food prices. The rate is expected to remain elevated for some time before cooling. The MPC expects the inflation rate to average 4.5 per cent this financial year. It is projected to be at 4.3 per cent in the first quarter of next financial year.

The latest Monetary Policy Report showed the RBI expected the inflation rate to moderate to 4.1 per cent in the fourth quarter of 2025-26, which will be close to its target of 4 per cent. The RBI is clearly willing to wait till the inflation rate durably aligns with the target of 4 per cent. This is a sensible policy position, given the inflation rate has been above target for several years now and growth is not a major concern at the moment.
 

Another important aspect touched on by Mr Das was currency management. It has been argued by some commentators, including on these pages, that volatility in the currency market is too low. The position of the RBI is that it doesn’t target any level and intervenes to contain excess volatility. India’s foreign-exchange reserves crossed $700 billion recently, though they declined below that level last week. Mr Das attributed the strategy of accumulating reserves to the lessons from the taper tantrum episode. A combination of factors, including the RBI’s reluctance to intervene in the currency market in the preceding period, led to a near-currency crisis in 2013, when the US Federal Reserve indicated a tapering of its quantitative-easing programme. The RBI doesn’t want to be in a similar situation again.
 

Consequently, it has consistently focused on accumulating reserves and containing excess volatility in the currency market. While the RBI has done well to quell excess volatility, as was witnessed during coordinated global policy tightening in 2022, it needs to be more selective in its interventions. Sustained intervention should not result in a consistent overvaluation of the rupee, affecting India’s external competitiveness. It ’s worth noting that the 40-currency trade-weighted real effective exchange rate showed the rupee was overvalued by over 5 per cent in August, an improvement from over 7 per cent overvaluation in July. It will be important for the RBI to make sure that the objective of containing excess volatility does not turn into strong currency policy bias. Sustained overvaluation can affect competitiveness and output with long-term growth implications.