The central bank appears to be in a tough spot. The INR has continued to depreciate to its lifetime low levels in Dec amid anecdotes of continued intervention in FX markets. The impossible trinity theory states that an economy cannot simultaneously achieve independent monetary policy, a fixed exchange rate and free capital movement. In resonance with our previous notes, the central bank appears to have already entered the state of unholy trinity – limiting the headroom to ease rates in the near term at a time when INR has continued to depreciate requiring intermittent FX intervention. In addition, the RBI, in its Dec meeting acknowledged that the inflation-growth dynamics appears to have turned adverse since the Oct policy meeting, with recent spike in inflation adding multiple risks to inflation outlook and expectations. Markets now watch FOMC meeting outcome later tonight, with a 25-bps easing discounted associated with a cautious guidance – keeping rates elevated in the near term.
