In exactly two weeks, the Reserve Bank of India (RBI) will have to take a decision on interest rates. Giving gratuitous advice on the morning of the meeting might be too late. Advice given a fortnight earlier might be somewhat useful.

In any case, columnists earn their living by being presumptuous and through giving gratuitous advice. Until some time ago, all speculation on monetary policy was whether RBI would cut rates and if so, by how much. That ceased when the US dollar vaulted above 60 Indian rupees. Now, most people are reconciled to the view that RBI would stand pat on rates on 30 July.

This reconciliation has come about despite the fact that India reported a slew of dreadful economic data on Friday. Even though the June trade deficit came in lower than it was in May, most people had figured out that it was due to the slump in gold imports for the month. Second, the recent rupee weakness combined with the higher price of crude oil could offset any decline in gold import. Industrial production data was uniformly bad and automobile sales declined. Usually, these data would have led analysts to call for rate cuts. The vulnerability of the Indian rupee has silenced these calls.

Of course, consumer price inflation at near 10% is another reason.

Now, the question is whether RBI should be tightening monetary policy. This newspaper was quick to notice that Brazil and Indonesia had raised their policy rates by 50 basis points in recent weeks. It left unanswered the question of what RBI should do on 30 July except noting cryptically that surprises could be in store.

Why does the question of a rate hike (or, any other suitable measure) crop up now as an appropriate response to India’s situation?

Honestly, the rupee is a currency without any fundamental support—either from policy or from performance or from flows. It needs to be anchored. Few weeks ago, this column noted that the simple calculation of the purchasing power parity of the rupee based on relative inflation differential with the US puts the number at over 70 against the dollar.

The problem is the balance sheet side of the equation. It is not just a question of the impact on foreign trade. The rupee’s weakness has turned a harsh spotlight on the rapid escalation in foreign corporate borrowing in recent years and strained the already distressed Indian corporate sector. Hence, India does not have the luxury of letting the rupee find its own level even if that is a tempting option for the central bank since it would not strain the bank’s dwindling foreign exchange reserves.

Usually, emerging economies tighten monetary policy when monetary policy in the US tightens and the dollar strengthens. In other words, their policy stance is synchronized with that of the US even though many of them have not officially pegged their currencies to the US dollar. But they operate as though that was their monetary regime. Hence, Brazil and Indonesia tightened at the height of the speculation over the US contemplating reduction of its monthly asset purchase or even terminating it. That was then. The Federal Reserve has moved on since then. Alarmed by the reaction in financial markets, the Federal Reserve has blinked. Put differently, they have tapered their talk of tapering asset purchases. In the last week, the dollar has weakened against the euro and other currencies consequently. Of course, now it is legitimate to ask if the Indian rates should go up to provide a shield for the Indian rupee and to bolster its attractiveness. After all, if the Fed were to hold off from doing anything to reverse its accommodative monetary policy, the dollar would weaken and the rupee might get a reprieve, regardless of what India does.

There are several responses to this argument. Increasing interest rates when pushed into a corner usually yields no support for the currency for it signals panic. Raising the rate when the country is not cornered shores up the central bank’s credibility and that of the currency. Hence, it is good to do so after the Federal Reserve tones down its tapering talk. Second, there is no other policy support for the rupee. Claims of fiscal rectitude have been diluted by the haste shown in implementing the Food Security Bill. Governance is, otherwise, conspicuous by its absence. Hence, monetary policy has to do all the heavy lifting, unfortunately. Third, global risk appetite can turn down any time. US stocks are trading at unsustainably high levels. Even the slightest disappointment can cause them to fall steeply. All efforts to prop them up have succeeded so far but market manipulation does not succeed forever. When risk appetite turns down, the floor will be removed from under the Indian rupee. It is better to cushion that fall now that there is a small window of opportunity to do so.

V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com.

To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk-

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