This question is in the context of the impossible trilemma. India does not have full capital convertibility on its currency. According to the trilemma, it should be able to have an independent monetary policy and a stable exchange rate. Yet, India has been forced to increase its lending rates in tandem with the Fed rate hikes, even though doing so will evidently damage its credit-fuelled economic recovery. So, we have a situation where India neither has full capital convertibility nor does it have a fully independent monetary policy. Its currency exchange rate is also not fully "stable", but "managed" or "floating". What happened here? Instead of standing on two legs after sacrificing one, how is India standing on three half-legs instead?


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The trilemma states that it is impossible to have all 3 of the following: free capital flow, fixed exchange rate regime, sovereign monetary policy.

This does not mean that a country will definitely have 2 out of 3. For example, a country with a floating exchange rate regime can impose capital flows.

However, your statement that India does not have independent monetary policy is incorrect. The Indian Central Bank is just reacting to the same issues the FED is reacting to. Just because they are moving in similar directions in terms of policy, does not mean they have no freedom over their policy. They are both just freely choosing similar policies, because they are faced with similar issues (inflation).

Just because you have independent monetary policy, does not mean you are immune to economic forces that make you optimally react somehow. In fact, without independent monetary policy, India may not have been able to optimally raise rates as it is doing now, but would have to react sub-optimally, e.g. to maintain the fixed exchange rate.


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