In a recent discourse on India’s foreign exchange policy, Viral Acharya, former Deputy Governor of the Reserve Bank of India (RBI), emphasized the need for the central bank to permit greater flexibility in the rupee’s exchange rate. Acharya contends that allowing increased volatility would enable the rupee to act as a natural shock absorber, enhancing the economy’s resilience to external disturbances.
Current Exchange Rate Management
The RBI currently employs a managed float system for the rupee, intervening in the foreign exchange market to mitigate excessive volatility and maintain orderly conditions. This approach aims to prevent abrupt currency fluctuations that could destabilize the economy.
Acharya’s Perspective
Acharya argues that the RBI’s interventions to stabilize the rupee may inadvertently suppress its natural response to global economic shifts. He suggests that a more flexible exchange rate would allow the rupee to adjust in line with market dynamics, thereby absorbing external shocks more effectively. This adjustment could enhance the competitiveness of Indian exports by reflecting true market conditions.
Implications for Monetary Policy
Acharya also highlights the potential benefits of increased rupee volatility for domestic monetary policy. A more flexible exchange rate could provide the RBI with greater autonomy in setting interest rates, as the currency would adjust to external pressures without necessitating direct intervention. This autonomy could lead to more effective management of inflation and economic growth.
Global Context
Acharya’s views align with practices in other emerging markets, where central banks allow greater currency flexibility to adapt to global economic changes. For instance, countries like Brazil and South Africa permit their currencies to fluctuate more freely, enabling their economies to adjust to external shocks without significant central bank intervention.
Potential Risks
While increased rupee volatility could offer benefits, it also carries potential risks. Greater fluctuations might lead to uncertainty for businesses engaged in international trade, affecting pricing and profit margins. Additionally, significant depreciation could increase the cost of imports, contributing to inflationary pressures.
Conclusion
Viral Acharya’s advocacy for allowing more rupee volatility presents a thought-provoking perspective on India’s foreign exchange policy. Balancing the benefits of a flexible exchange rate with the potential risks requires careful consideration by policymakers. As global economic conditions continue to evolve, the debate on optimal currency management strategies remains highly pertinent.
