04/01/2021
Impossible trinity is a trilemma where the central bank is unable to undertake all three fundamental decisions at the same time which are, ‘Independent Monetary Policy’, ‘Fixed Exchange Rates’, ‘Free Capital Flow’. If expansionary monetary policy is undertaken and interest rate is brought down, foreign capital inflow goes down and value of currency decreases (depreciation). If, on the other hand, contractionary monetary policy is undertaken and interest rate is increased, foreign capital inflow goes up and value of currency increases (appreciation).
India had seen a contraction of 23.9% in first quarter of financial year. Amidst the ongoing pandemic, due to supply chain disruptions and lockdown, both core and sticky inflation have persisted in the economy, due to which RBI has been reluctant to cut interest rates and as foreign capital inflow continues to increase, recovery of economy through exports doesn’t seem feasible as a stronger rupee has made the exports costlier.
To maintain the yield curve in order the market would need assurance that inflation is under control, however there has been huge amount of foreign capital incoming (Rs. 174,793 Crore, FDI inflow during second quarter) and RBI has already increased liquidity with banks due its forex market intervention., to resist this appreciation RBI has been purchasing dollars, in turn which has increased liquidity in the market.
RBI has pledged to keep the interest rates on hold as it takes an accommodative stance however in course of time something will give as the current situation cannot be held forever, We should therefore expect quick policy reversals in the future as the economy starts picking up pace again.
Yuvraj Pratap Singh
(Batch of 2021)