Changed in the RBI’s Currency Policy

Source: The post Changed in the RBI’s Currency Policy has been created, based on the article “Unshackling the Indian Rupee” published in “Indian Express” on 9th November 2024

UPSC Syllabus Topic: GS Paper3- Indian Economy

Context: The article discusses the Reserve Bank of India’s recent decision to actively intervene in the foreign exchange market, which has led to the rupee becoming more stable. This policy is criticized for distorting market signals, potentially harming exports, and lacking transparency.

For detailed information on The RBI’s Currency Management read this article here

What Has Changed in the RBI’s Currency Policy?

1. Increased Intervention: Since late 2022, the RBI has intervened actively in the forex market to stabilize the rupee, buying dollars to prevent appreciation and selling to prevent depreciation.
2. Reduced Volatility: Rupee-dollar volatility dropped to 1.9% between April 2023 and August 2024, compared to the earlier average of 5% (1991-2020).
3. Shift from Market Forces: Unlike the euro-dollar exchange rate driven by free markets, the rupee’s stability stems from RBI’s actions.
4. Pegged-Like System: The rupee now resembles a pegged exchange rate, raising concerns over export competitiveness and transparency.

Why is the RBI’s Increased Intervention Problematic?

1. Market Distortion: Pegging exchange rates distorts demand-supply signals, harming the economy, as seen in pre-1991 India.
2. Export Impact: Real exchange rate appreciation makes Indian exports costlier, hurting the Make in India initiative.
3. Global Examples: Countries like Argentina and Thailand faced crises after pegging their currencies.
4. Transparency Issues: Lack of clear communication from RBI confuses private market participants, undermining trust and efficient market functioning.

What Were the Benefits of India’s Earlier Flexible Exchange Rate Policy?

1. Economic Stabilization: During high growth periods, the rupee appreciated, preventing overheating. During downturns, depreciation boosted exports and supported recovery.
2. Real Exchange Rate Stability: Long-term balance was maintained, adjusting for inflation differences with trading partners. This supported sustainable trade competitiveness.
3. Export Competitiveness: Flexible rates ensured exports remained attractive by reflecting market-driven demand and supply.
4. Market Efficiency: The system allowed natural economic adjustments without state interference.

What Are the Consequences of the Current Policy?

1. It undermines India’s Make in India initiative by making exports costlier.
2. It confuses businesses and investors, disrupting market efficiency.
3. The long-standing flexible exchange rate system, which worked well, has been replaced unnecessarily.

Question for practice:

Examine how the Reserve Bank of India’s increased intervention in the foreign exchange market has impacted India’s export competitiveness and market efficiency.