When market players were waiting for the red card to be flashed for a macro-economic foul, referee Reserve Bank of India ( RBI ) turned the other way.Conventional wisdom demanded that when a country is running a current account deficit ( CAD ) and a depressed currency raising the spectre of imported inflation , the central bank enhance the cost of funds – to deter demand and attract overseas investors.Furthermore, the contagion sweeping emerging markets because of hardening US interest rates led almost every reasonably big economy to raise interest rates steeply as prescribed by text books. The RBI, which has been raising interest rates when industry and government were pleading for lower cost of funds, did the opposite of what would have been the logical step – to walk in lockstep with EM peers and raise rates.In normal circumstances, pundits would have termed the status quo as an attempt to keep the government happy. Under this governor who has been steadfast in holding on to his decisions that have ruffled the administration, even that commentary is not forthcoming.Contrary to the central bank’s attitude, the government has been coming up with decisions to steady the rupee and efforts to lower the impact of rising fuel costs on consumers’ pocket. Are the two working at cross purposes?“The government has already taken tentative steps to tackle the current account deficit and attract capital flows,” says A Prasanna, economist at ICICI Securities Primary Dealership. “But, RBI appeared reluctant to venture in that direction, indicating that it is comfortable with the broader macro-economic parameters.”The central bank kept interest rates unchanged at 6.5% after its review last week, citing the possibility of lower inflation due to benign food prices even though it acknowledged the upside risks from rising crude oil prices.This shocked the market which was expecting a quarter point increase, as central banks from Indonesia to Argentina have raised rates to defend currencies . India is no exception, with the rupee sliding to a record low of Rs 74 to the US dollar.The government has announced a raft of measures that would help rein in the rupee. Besides, relaxing ECB and withholding tax on masala bonds, the government has also done away with mandatory hedging of overseas borrowings for infrastructure companies.“Dollar reserves are large — 10 times the import cover, five years’ CAD and 10 years from balance of payments perspective,” said economic affairs secretary Subhash Chandra Garg. “Still, we have taken measures to improve it further. The oil marketing companies have been allowed to raise $10 billion. ”The Indian rupee is among the worst performing EM currencies, falling 14% this year. Demands to shore up the rupee included a special deposit scheme for NRIs, as was done in 2013 and raising interest rates, and the RBI selling US dollars to meet the demand. While the headline of record lows for the currency leads to discomfort, it is also true that other currencies, including the Chinese Yuan are sliding due to the overall strength of the US dollar.“Economic and political sensitivity to a weaker rupee has risen, but Friday’s rate decision signalled that the central bank prioritised its inflation mandate, rather than getting fixated with the currency direction,” says Radhika Rao, economist at DBS.“NRI bond , if rolled out this year, will attract strong interests, but the boost might be temporary if the global risk environment remains jittery. Even if many other central banks are turning into fullservice regulators taking decisions based on financial stability and other factors, the RBI is now emphasising more on keeping inflation at 4% and within two percentage point band on either side.“Exchange rate is a price,” says RBI deputy governor Viral Acharya. “Rupee-dollar is a fairly deep market. It gets determined by supply and demand forces. Managed float is what roughly RBI’s policy is . As far as interest rates are concerned, it is exclusively focused on its mandate of flexible inflation targeting.”In an inter-linked world, it may not be right to just look at the exchange rate between the rupee and US dollar, but also the rates between yuan and other currencies which compete in global markets. “While it is nobody’s case that a 25-bps hike will by itself address excess demand or attract capital inflows, by not hiking India does stand out among CAD countries in the EM space,’’ says Prasanna.The current strategy also reflects the central bank’s policy that it is more inclined to let the market forces of demand and supply adjust the imbalances such as the Current Account Deficit rather than meddling with it that causes further distortions.CAD is expected to widen to 2.8% of the GDP, from 1.8% last year. Despite record prices at petrol stations, consumption continues to grow at 5.6% in the April-June quarter, compared with 3.3% in the same period a year ago, show data from the petroleum ministry.Imports of electronic items have risen 33% in August this year to Rs 38,387 crore, from Rs 29,592 crore in the same period a year earlier. With such a strong demand for imported products, intervening to keep the rupee strong or avoid weakness would cause further widening of the CAD. Instead, a weak currency could arrest demand and even raise exports.“The primary responses include maintaining steadfastly inflation credibility of monetary policy, sticking to the fiscal policy targets at the general government level, allowing flexible exchange rate adjustment without undue volatility to help reorient current account balance given the revised terms of trade,” said RBI Governor Urjit Patel While the current status quo may appear to be out of sync with the rest of the world, rates in India have already tightened sharply with the benchmark bond yields rising 85 basis points from its lows of 7.12% in April. Also, the spread between the 10-year US treasuries, which was 456 basis points in April, has actually risen by 25 bps to 479 bps between April and now.India’s real interest rates is high at 3.97% with inflation forecast at 4% for the current fiscal. That may have led to a pause, but it may have just postponed the rate increase.“If we assume the MPC’s preference of 175 to 200 basis points real rates over its legislated 4% CPI target in medium term, two more rate hikes look highly probable,” says Anubhuti Sahay, economist at StanChart. The actions and commentary from the RBI appear unconventional, but will it be able to pull them through with an acceptable slide of the currency without interest rate actions?“It is also likely that the RBI preferred to preserve ammunition as we are in the midst of an environment which is likely to remain challenging for a protracted period of time,” says DBS’ Rao. “So, preference might be to act when there are palpable signs that supply-side shocks are translating into higher inflation or inflationary expectations.”There is little indication from the central bank that it is in a panic mode, unlike many in the markets who would like it to behave. Currency forecasters are already calling for the Rupee to go beyond Rs 75 to the US dollar, and some indicated in an ET poll that it may even test Rs 77.“At the margin, the appearance of divergence of objectives between the RBI and the government will embolden speculators,” says ICICI’s Prasanna. For now, however, the government and the RBI seem to be reading the macro tea leaves differently.