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India is ready to use other measures to fight inflation other than interest rates in dealing with price pressures. What tool is it?

India is ready to use other measures to fight inflation other than interest rates in dealing with price pressures.
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India is ready to use other measures to fight inflation other than interest rates in dealing with price pressures.

Highlights

Consumers in India have been feeling the pinch of rising energy and food prices as their economy loses its growth momentum. The Indian economy is now growing at its laggard pace in the last six years.

Consumers in India have been feeling the pinch of rising energy and food prices as their economy loses its growth momentum. The Indian economy is now growing at its laggard pace in the last six years.

At the beginning of the year, the South Asian country's ministry of statistics predicted that the economy would grow by 5 percent. The effects of the COVID-19 pandemic have dampened this optimistic outlook having a contagion on the vital Forex trading markets.

The ongoing challenge of rising inflation has also adversely affected Narendra Modi's drive to revive the dragging economic growth. The annual inflation rate is at its highest in five years. Consequently, surging oil and food prices have intensified a likelihood of an extended break in India's central bank rate cuts.

Historically, an over four percent inflation rate has always made the Reserve Bank of India uneasy. It has in the past reacted to this phenomenon by raising its repo rate. As an illustration, in September 2011, the RBI hiked its policy lending rate for the twelfth time in less than 18 months to curb a 9.7 percent high inflation rate.

This situation has always left the bank in an awkward position of confronting high prices in an environment focused on economic growth. High inflation limits not only its citizen's spending power but hurts the value of its currency. Inflation has a major impact on the rupee's foreign exchange rate, making its return less favorable.

Change of Tact at the RBI

This time round, however, the RBI seems unfazed by the high inflation rate problem. Going against all expectations, the RBI has hinted that it will instead allow the Rupee to strengthen further to help the world's most populous democracy handle its imported inflation.

The Indian rupee has been gaining strength in the last few months. The country's central bank has allowed this appreciation, leaving its exchange rates untouched. India, the world's second-most populous nation, had a fixed exchange rate fixed to the pound sterling, and later moved on to a basket peg in the 80s.

Today, the currency market's demand and supply forces dictate the Indian exchange rate system. That said, the RBI often intervenes to establish the exchange rates for stability since the country highly depends on imports.

The latest surge in Rupee value is attributed to an increase in foreign investments and capital. There has been a surge in direct and institutional investments as foreign investors take a keen interest in India.

In doing so, there has been a huge inflow of dollars into India's economy. To counter the effect of the dollar inflow on the value of the Rupee, the RBI bought dollars via India's state-run banks to keep the rupee's value in check.

This action kept the official currency of the country from appreciation. In the last few days, the RBI seems to backtrack on this action, allowing the rupee to appreciate.

India's Imported Inflation Challenge

Imported inflation causes sudden increases in prices as the cost of imports rise because of high inflation rates in an exporting country. The increase in costs can also result from an increase in customs duties.

The Indian government has hiked duties in the past to protect its industries from the effects of imported inflation. This time, however, the RBI has decided that the appreciation of the rupee will keep imported inflation and price pressures in check instead.

This move could have better effects for the economy because increasing rates in a contracting economy could lead the struggling economy to a downward spiral with catastrophic effects.

A strong rupee will have a positive effect on consumer durable businesses, especially those that deal with imported crude oil and its derivatives. Businesses that have enormous debt denominated in foreign currency in the power sector will also feel relief from a robust rupee.

The effect of the stronger rupee is negative for earnings, but it will prove to be a plus for the equity market.

The Bank of America has labeled the appreciating value of the currency a bullish sign. Investors will pour more capital into higher risk instruments in emerging market currencies. These currencies are more volatile, making them a plum choice for the higher risk investment hungry forex market.

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