IMF says rupee should absorb energy shocks, flags inflation risks from depreciation

The International Monetary Fund (IMF) on Thursday said exchange rate flexibility should be India’s preferred response to energy-related external shocks, arguing that allowing the rupee to adjust would help the economy absorb their impact.

The comments come amid reports of significant Reserve Bank of India (RBI) intervention in the foreign exchange market to support the domestic currency.

“Our view is that the rupee should be the first line of defence in the face of these shocks. So, allowing the exchange rate to move freely to reflect the impact of these shocks is important to help the Indian economy adjust to the shocks,” IMF Communications Director Julie Kozack told reporters in Washington.

Exchange rate should act as first line of defence

The IMF’s position suggests that the exchange rate should be allowed to reflect the impact of external developments rather than being defended through sustained intervention. A flexible rupee would help absorb the pressure arising from higher energy costs and allow the economy to adjust to changing global conditions.

The remarks come at a time when the RBI has reportedly stepped up its intervention in the foreign exchange market to support the rupee amid external pressures. While the supplied statement does not quantify the central bank’s intervention, the IMF’s comments underline the importance it attaches to exchange rate flexibility as a policy response.

IMF flags inflation risks from rupee depreciation

Responding to a question from PTI, Kozack said the IMF would recommend monetary policy tightening if depreciation of the rupee began feeding into domestic inflation.

This signals that the Fund sees a distinction between allowing the currency to adjust to external shocks and responding to the inflationary consequences of that adjustment. In other words, exchange rate flexibility should help the economy absorb the initial shock, while monetary policy should address any resulting price pressures.

For India, energy prices are an important external vulnerability because higher import costs can put pressure on the trade balance and the rupee. A weaker domestic currency can, in turn, make imported commodities more expensive, potentially adding to inflation.

The IMF’s comments therefore point to a two-pronged policy approach: allowing the rupee to respond to external shocks while tightening monetary policy if currency depreciation starts translating into broader domestic price pressures.

Kozack’s remarks were made during the IMF’s interaction with reporters in Washington on Thursday.