Answer:

♤ Monetary Policy Trilemma also known as ‘impossible trilemma’ refers to the incompatibility of retaining monetary policy sovereignty in the face of a convertible capital account and flexible exchange rate. In other words we cannot have all of the three together –

o A fixed exchange rate

o Free capital movement (absence of capital controls)

o An independent monetary policy

♤ An economy open to free movement of capital can keep a fixed exchange rate, for example, only by subjugating monetary-policy independence —by raising interest rates sharply, say, when capital outflows put downward pressure on the currency. Yet the trilemma also implies that an economy can enjoy both free capital flows and an independent monetary policy, so long as it gives up worrying about its exchange rate.

♤ Therefore instead of sweating over keeping the exchange rate under check, India must work towards the underlying reasons

o India is a country which has a perennially high CAD problem which make its currency vulnerable to external pressures, which get accentuated at times when something like tapering is announced

o Hence the way forward is to-

 increase our exports by diversification of products and markets,

 curb the unproductive imports by rationalization of petroleum subsidies, and

 also make India more attractive a destination for long term capital in form of FDI instead of hot money (Portfolio investment) by improving upon the

‘Ease of Doing Business Index’ parameters, better regulatory mechanisms

etc.

♤ A positive CAD or a negative CAD that can be financed by FDI inflows will shield Indian rupee as well as independence of our monetary policy from external shocks.