There are basically three main objectives of Indian monetary policy: 1: Growth 2: Price Stability 3: Exchange rate stability

One of the biggest limitations of monetary policy is that it is trying to achieve its objective using one instrument i.e. targeting interest rate which is not advisable. For each objective different instrument should be used as steps taken towards one of the objective normally goes against the other objective. For e.g. if government increase interest rate to target inflation then it may affect the growth and exchange rate as the firms will find it difficult to take loan and this it will affect the expansion and thus will slowdown growth. Also increase interest rate can increase cost of the goods and thus making our exports less competitive which can affect the inflow of foreign currency thus affecting the exchange rate stability. Right now what the RBI is finding it most harmful to the economy is Inflation and exchange rate fluctuation. So right now the monetary policy is trying to control inflation at the expense of growth by continuously increasing the repo rate. The rationale behind this move of RBI is that once Inflation goes out of control then it becomes very difficult to control the same. Secondly due to high inflation savings of people are diverted from saving accounts and financial assets to physical assets as saving accounts and financial assets are not giving any significant real rate of return due to high inflation. Since the saving are not coming into financial sector so there is less spending on investment activities due to lack of capital and which is affecting the growth and development of country. Since RBI cannot affect the supply side constraint and increase in capacity takes time so in short term it makes sense to tackle demand which is being done by RBI by increasing the repo rate. The increase in repo rate has decrease the liquidity in the market thus reducing demand and thus helps in controlling inflation. The actions of RBI are also proving a step in right direction in tackling the other problem with the economy i.e. instability of exchange rate. There are many negatives effects of instable exchange rate and the free fall of rupees. First of all many Indian firms have loans in foreign currency and the downslide of rupee has affected them very badly as they now had to pay significantly more towards the interest payment and principal amount. Secondly it has also reduced the investor confidence in the country and global investors are unlikely to be lured by 10-year government bonds, even though their percent yield is far more attractive than the return on comparable U.S. Treasuries. Investors will bite only if they can get a positive return after hedging the currency risk rate of which is very high due to instability in exchange rates. Thirdly since India is a net trade deficit country the depreciation of rupee will lead to widening of its current account deficit thus having negative effect on both the financial stability of the country and its image as an investment option.

So RBI is trying hard to tackle the problem of exchange rate instability by implementing a lot of measures. The increase in repo rate has decrease the liquidity in market which increased the demand for Rupee leading to its appreciation. RBI has also taken some measures to increase the forex reserves and prevent depreciation of rupee by making sufficient availability of dollars in the market and also reducing the demand for the same. This was done by first putting restrictions on the import of gold which provide significant relief in the demand for dollars. Secondly providing swap window for FCNR Bond deposit having maturity of 3 years and above at a fixed rate 3.5 % in September have attracted more than $34 bn which have eased the situation to a great level. Also decrease in demand due to liquidity crunch has also reduced imports that have reduced the demand for dollars. All these measures reaped well and brought down the CAD to record low level of $ 5.3bn in July Sept quarter which is just 1.2% of GDP Thus, right now measures followed by RBI are proving beneficial to the economy to fight back the two big problems namely Inflation and exchange rate instability.