There is only one consequence of this: banks will be even more reluctant to lend than they have been hitherto. This squeeze on credit will be disastrous for any hope of an investment recovery, and thus a relatively smooth return to higher growth. And what is being purchased at the cost of the India growth story? A dubious, and almost certainly temporary, protection of the exchange rate of the rupee. Making this choice is not only the wrong thing to do, it is also self-defeating. After all, when international investors see that growth will slow thanks to a credit crunch, they will pull money out of the equity markets. Then the rupee will fall further. And if the RBI tries to defend it, then a crisis will be precipitated - as happened with some of the countries in Southeast Asia in the 1990s. In any case, a defence of the rupee will only give foreign institutional investors (FIIs) higher returns as they exit, at the cost of Indian borrowers.
So the message to investors that the RBI has managed to send is: get out while the going is good. Neither credit rating agencies nor FIIs are likely to ignore these signals. Nor is it reassuring for any observers to see the government tackling the symptoms (pressure on the rupee) instead of the cause (a structurally high current account deficit). The market has seen this: even if the rupee has held tight, the forward premiums for buying dollars have exploded upwards to levels last seen in the 1990s. If the government continues to focus on the symptoms, it will send India back to the 1980s - with an overvalued exchange rate, crisis threats, visits to the International Monetary Fund and a thriving illegal business in gold smuggling. True, a weaker rupee would make the government's fiscal deficit worse, since fuel subsidies would cost more - but the answer is for New Delhi to take the correct decisions to cut the deficit, not for it to strangle growth further in co-ordination with the central bank.