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Amid geopolitical uncertainty and the West Asia crisis weighing on local currency, the Former RBI Governor Duvvuri Subbarao has said the central bank must allow some more depreciation in the rupee to help absorb external pressures, and choose liquidity measures, rather than going for rate hikes, if inflation risks intensify. He noted that the monetary policy should be used as a ‘last resort’ to defend the exchange rate. Further, the rupee should be allowed to adjust rather than be rigidly defended because the current pressures reflect a deterioration in India's external balance. A weaker rupee acts as a natural shock absorber.

Subbarao pointed that stabilising the exchange rate during times of pressure is fundamentally a challenge of managing expectations and the Exchange-rate crises are ultimately crises of confidence. He added that if investors, importers and households begin to believe the rupee will weaken further, they behave in ways that actually make it weaken further. Exporters delay bringing money back home, importers rush to buy dollars, households move into gold, and investors hedge aggressively. Therefore, communication becomes as important as intervention and policymakers must act decisively, but without appearing panicked or defensive.

Moreover, he highlighted that Monetary Policy Committee has a difficult balancing act with limited room to manoeuvre. He pointed that that lowering interest rates to support growth could aggravate inflation and intensify exchange-rate pressures, while aggressive rate increases could hurt economic activity and impact the GDP growth. For the current situation, he suggested that RBI should wait and assess whether inflationary pressures become broader through the system, instead of immediately resorting to policy rate hikes.