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Leeway on the rupee

Photo: ReutersPremium
Photo: Reuters

An erosion in purchasing power implied by high domestic inflation could weigh it down further, as also a drop in the exchange rate itself, as price-inelastic imports get even dearer in local money.

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The Indian rupee is having a tough run. On Thursday, it fell to a fresh all-time low against the dollar. Blame a mix of reasons. For one, inflation in the US is near a multi-decade high, and the rate incline taken by Federal Reserve policy is drawing hot money into dollar assets, thus weakening other currencies in relation to America’s. India was also hit by a war-created oil shock, which enlarged import bills and widened our trade gap. Growing Indian demand for dollars has put added pressure on our currency. An erosion in purchasing power implied by high domestic inflation could weigh it down further, as also a drop in the exchange rate itself, as price-inelastic imports get even dearer in local money.

As India’s foreign exchange reserves dipped below $600 billion, it was clear our central bank had been selling dollars in support of the rupee. By stated policy, it intervenes only against rate volatility while otherwise letting it find its own float value. A jerky currency is disruptive. As our managed float affords us some flexibility in its management, we could also explore a priority-adapted strategy. Gita Gopinath’s academic work on a nuanced way around trade-offs could be of help in this.

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