The Rupee Does Not Need a Speaking Role in Monetary Policy

As the rupee comes under pressure and the familiar debate over exchange-rate defence resurfaces, calls are growing for the Reserve Bank of India to consider monetary policy as part of the response. The argument is not new, as similar questions emerged during the 2013 taper tantrum, when the RBI deployed a series of extraordinary measures to stem currency volatility.

The circumstances today, however, are different, as are the communication challenges. India now operates under a formal inflation-targeting framework, under which the policy repo rate is intended to respond to inflation and growth rather than any particular level of the exchange rate. Whether the Monetary Policy Committee raises rates, cuts them or stays on hold will therefore be important not only in its own right, but also for what its accompanying communication reveals about how policymakers view the rupee's recent weakness.

Markets will therefore be parsing not only the policy decision but also the reasoning accompanying it. The policy statement, the Governor's press conference and, perhaps most importantly, the minutes of the MPC meeting will be scrutinised for clues about how members view the rupee's depreciation and its implications for the inflation outlook.

A reference to imported inflation would not be unusual, as a weaker currency can raise the domestic cost of fuel, commodities and other imports, potentially influencing inflation. Any inflation-targeting central bank would be expected to monitor those risks and incorporate them into its assessment of the outlook.

While the RBI may be concerned about the inflationary consequences of currency weakness, it will want to avoid creating the impression that monetary policy is being calibrated to influence or defend a particular level of the rupee.

The central bank has repeatedly emphasised that it possesses a range of instruments to deal with disorderly movements in foreign-exchange markets. Intervention operations, liquidity measures and other market tools exist because exchange-rate management and monetary policy do not always need to move in tandem. Preserving that separation has helped provide clarity around the objectives of monetary policy.

The outcome of the June review will be known immediately, but the interpretation of the RBI's communication may linger much longer. At a time when the rupee is attracting increasing attention, the RBI's communication challenge is to ensure that concern about imported inflation is not mistaken for a change in the objectives of monetary policy.