The sledgehammer used by the Reserve Bank of India (RBI) has led to questions on whether it will halt the foreign fund outflows seen over the past few months and rein in inflation.
Though views differ, some economists said an increase in interest rates raises the appeal of domestic assets (such as bonds) which could lead to higher inflows, thereby aiding the domestic currency.

“The rate increase by the RBI puts in place a pre-emptive ‘traditional defence’ for the rupee against capital outflows as global monetary policy tightens,’’ Abheek Barua, chief economist at HDFC Bank, said in a note.

Foreign portfolio investors have been pulling out money since October last year and they have sold stocks worth Rs 1.29 trillion and debt of Rs 9,098 crore beginning February.
This came as other central banks such as the US Fed began to withdraw their accommodative policies. The RBI stayed put and inflation inched up globally, triggering interest in alternative assets such as the dollar.

India’s forex reserves have consequently fallen to $ 600.42 billion as on April 22, from $ 634.97 billion on January 14 – down 5.4 per cent.It remains to be seen if the step is enough to boost the rupee amid aggressive tightening by the US Federal Reserve. At the forex markets today, the rupee gained by 26 paise during intra-day trades to hit a high of 76.22 against the US dollar. However, a stronger US dollar overseas saw the unit paring its advance to close at 76.40-a rise of 8 paise over the last close.

While the upward revision in the repo rate was done to control inflation, it has also led to questions on whether the step was taken anticipating another sharp increase in retail inflation print in April. Some of the economists expect it to come between 7.5-7.9 per cent.

However, even after the hike some economists do not expect any big relief coming on the inflation front. HDFC Bank for instance feels that the CPI inflation will average above 7 per cent in the first half of this fiscal and at 6.5-6.7 per cent for 2022-23 with further upside risks to this forecasts.

Amid such an expectations, some economists are arguing for the Government to cut duties on petrol and diesel. According to Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India, measures to ameliorate supply-side cost pressures would be critical at this juncture, especially in terms of a calibrated reduction of taxes on petrol and diesel. He added that this would help anchor inflation expectations, prevent build-up of a wage-price nexus and provide space for monetary policy to sustain support for the still incomplete growth recovery.