RBI Should Allow More Rupee Volatility, Ex-Central Banker Says
AInvestMonday, Jan 6, 2025 2:12 am ET
2min read


The Reserve Bank of India (RBI) has been under scrutiny for its foreign exchange strategy, with some experts advocating for a more flexible approach to rupee volatility. In a recent interview, an ex-central banker argued that allowing more rupee volatility could help India's export competitiveness and trade balance. This article explores the potential benefits and risks of increased rupee volatility and the RBI's role in managing it.



Potential Benefits of Increased Rupee Volatility

1. Improved Export Competitiveness: A more volatile rupee can make Indian exports cheaper in international markets, enhancing their competitiveness. This can boost exports and contribute to economic growth (Source: "RBI needs to rethink strategy").
2. Deterrent to Speculative Gold Imports: A more volatile rupee can discourage speculative gold imports, which have been surging. This can help reduce the trade deficit and ease inflationary pressures (Source: "RBI needs to rethink strategy").
3. Natural Stabiliser: Increased rupee volatility can act as a natural stabiliser, helping to smooth out large fluctuations in the currency's value. This can be achieved by the RBI strategically buying dollars when the rupee is strong and selling when it is weak, which helps to maintain stability in the currency (Source: PIB, 2024).

Risks and Challenges

1. Increased Import Prices: A depreciating rupee could lead to higher import prices, particularly for commodities like crude oil, which India heavily imports. This could increase production costs for domestic industries and potentially lead to higher inflation (Source: "The rupee is under pressure").
2. Higher Interest Rates: A more volatile rupee could lead to higher interest rates, as investors demand higher returns to compensate for the increased risk. This could make borrowing more expensive for businesses and households, potentially slowing economic growth and increasing inflation (Source: "Interventions and trade-offs").
3. Uncertainty and Market Confidence: Increased rupee volatility can create uncertainty and erode market confidence, making it more difficult for Indian companies to raise capital and attract foreign direct investment (FDI).

The RBI's Role in Managing Volatility

The RBI plays a crucial role in managing rupee volatility to support India's economic growth and stability. Some measures the RBI can implement to manage and mitigate the risks associated with higher rupee volatility include:

1. Intervention in the foreign exchange market: The RBI can intervene in the foreign exchange market by buying or selling dollars to smooth out large fluctuations in the rupee's value. This helps to maintain stability and reduce volatility.
2. Building and managing foreign exchange reserves: The RBI can build up a large reserve of foreign currency, which can be used to manage volatility. India has built up one of the world's largest reserves of foreign currency, which helps to contain volatility in the rupee.
3. Managing "hot money" flows: The RBI can manage "hot money" flows, which can quickly enter and exit the market, causing volatility. This can be done by implementing measures such as capital controls, sterilization operations, and macroprudential policies.
4. Promoting the international use of the rupee: The RBI can work to increase the international use of the rupee, especially for trade. Enhancing the rupee's global presence can further stabilize its value and reduce volatility.
5. Improving communication and transparency: The RBI can improve communication and transparency regarding its exchange rate policies to anchor market expectations and avoid unnecessary panic.

In conclusion, while allowing more rupee volatility could have some positive effects on India's export competitiveness and trade balance, it could also have negative effects, such as increased import prices and higher interest rates. The RBI must carefully balance these factors when deciding on its foreign exchange strategy. By implementing appropriate measures to manage and mitigate the risks associated with higher rupee volatility, the RBI can ensure the stability and resilience of the Indian economy.
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