Definition
Trilemma (Impossible Trinity)
The impossible trinity states that a country cannot simultaneously have a fixed exchange rate, free capital movement and an independent monetary policy; it can pick only two.
If India wanted a fully fixed rupee and open capital flows, it would have to give up control of its interest rates. Instead India chooses monetary independence (the RBI sets rates) plus a managed exchange rate, and accepts only partial capital-account openness.
This framework explains why the RBI maintains capital controls and a flexible rupee: it preserves the ability to set domestic policy for inflation and growth. Hong Kong, with a hard dollar peg and free capital flows, has surrendered monetary independence entirely.
Related terms
- Managed FloatA managed float, or dirty float, is a regime where the exchange rate is largely market-determined but the central bank intervenes to curb excessive volatility.
- Capital Account ConvertibilityCapital account convertibility is the freedom to convert local financial assets into foreign assets and back at market rates without restriction, which India only allows partially.
- Currency PegA currency peg fixes a currency's exchange rate to another currency or basket, requiring the central bank to buy or sell reserves to defend the chosen level.
- RBI Monetary PolicyRBI monetary policy is the central bank's use of the repo rate and liquidity tools, guided by an MPC mandate to keep CPI inflation at 4% within a 2-6% band, to manage inflation and support growth.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.