Fri. Mar 29th, 2024

According to economists, Reserve Bank of India’s exchange rate management will emphatically help the central bank manage cost push inflation in the economy.  Cost push inflation is the rise in the general price level in the economy due to rise in cost of production. According to RBI’s research report, inflation could be impacted by 0.1 to 0.13% for every 1% change in exchange rate.

The research report underscored that letting the Indian rupee appreciate in the foreign exchange market will help the central bank manage inflation. Controlling inflation comes at a time of a possibility of higher domestic inflation due to supply side constraints. Supply constraints in the economy come as various states in India are now implementing partial or complete lockdowns in pursuit to curb the spread of covid 19 in the economy.

Group chief economic advisor, Soumya Kanti Ghosh and his team in the report stated that “The good thing is that given the prospects of higher domestic inflation, as supply disruptions mount, it is not doing any harm for RBI to lean with the wind and let rupee appreciate as it is reducing imported inflation when metal prices are rising, and clearing the liquidity overhang to some extent”. The report further stated that  ”In fact, the large supply of dollars will ensure that rupee will appreciate from the current levels and this could potentially play to the advantage of RBI in inflation management”

As per reports, estimates of exchange rate suggest some moderation during the flexible Inflation targeting period. In the report it was stated that ‘inflation can still alter by 0.1-0.13% for every 1% change in exchange rate, warranting that the exchange rate be closely monitored as a key information variable for the conduct of monetary policy”.

But it is to be noted that according to a recent report by RBI, the monetary policy rate is not found to respond directly to exchange rate movements or the federal funds rate. Although the conduct of monetary policy is quite sensitive to both global and domestic financial shocks.

The severe second wave of the pandemic also poses a considerable  challenge to exchange rate management by the RBI. Since India is currently in the initial phase of its vaccination drive, which needs to be ramped up and is in the midst of a catastrophic second wave, there is a definite possibility that capital flows reverse and exchange rate could start depreciating. This could lead to rise in inflationary pressures which will mount further, thus complicating the task of MPC to balance the trade-off between growth and inflation.

For an inflation targeting regime, the key target variable is inflation but in the current situation growth concerns outweigh inflationary pressures. So the MPC will have to be watchful of a depreciation induced inflation.

By Shivani Khanna

A woman who believes in equal rights and aspires to inspire people through her writings. I aspire to contribute to the economic world and society with diligence and thus being an economic advisor tops my career ambitions . I currently am pursuing Economic honours ( at undergrad level) from delhi university.