MUMBAI: Almost a year after Reserve Bank of India Governor Raghuram Rajan rescued the rupee from a collapse, his war on inflation remains key to safeguarding the currency.

Rajan, who kept borrowing costs unchanged last week even as price gains slowed and foreign reserves climb toward a record, said developing economies with high inflation risk major market volatility when developed nations end monetary easing. The rupee tumbled 1.9 percent to 61.095 per dollar in one month, Asia’s worst performance, on speculation improving US data will prompt the Federal Reserve to raise interest rates next year.

“With external vulnerability reduced significantly and foreign reserves beefed up, India is better placed to deal with the normalization of US rates,” Gaurav Kapur, senior economist at Royal Bank of Scotland Group Plc in Mumbai, said in an Aug. 8 phone interview.

“However, the weakest element in the defense against capital outflows is still high inflation.”

Rajan raised borrowing costs three times since taking office in September to rein in the worst inflation among major Asian economies and avoid a repeat of last August’s selloff that caused the rupee to sink to an unprecedented 68.845 per dollar.

The currency has since rebounded about 12 percent as global investors bought Indian assets, boosting foreign-exchange reserves to a near record $320 billion last week.

While the rate increases have helped bring inflation below the RBI’s 8 percent target for January 2015, it is set to accelerate.

Consumer prices rose 7.4 percent last month from a year earlier, compared with 7.3 percent in June, according to the median forecast of analysts surveyed by Bloomberg before official data due Tuesday.

Rajan left the RBI’s benchmark repurchase rate unchanged at 8 percent on Aug. 5 and said there is an upside risk to his goal of slowing price gains to 6 percent by January 2016.

His statement dropped a June reference to the possibility of easing policy should inflation decline faster than anticipated.

High inflation creates a tendency for a currency to depreciate and discourages overseas investment, Rajan said according to an Aug. 7 report in India’s Economic Times that cited the governor’s comments to local newspaper reporters.

The world is at risk of another financial crisis as monetary stimulus in developed economies encourages investors to take risks and boost asset prices, Rajan told the British newspaper The Times.

There will be “major market volatility” if investors exit their positions simultaneously, he was quoted as saying by the Central Banking Journal.

One-month implied volatility in the rupee, a gauge of expected exchange-rate swings used to price options, has risen 245 basis points from a 2011 low on July 29 to 7.75 percent.

US Fed Reserve Chair Janet Yellen said last month US borrowing costs may rise sooner should the American labor market improve faster than anticipated by the central bank.

“The RBI’s decision to keep rates unchanged is aimed at tackling inflation and strengthening its defenses in case there is a bout of volatility,” when the US raises rates, Pradeep Khanna, head of currency trading at HSBC Holdings Plc in Mumbai, said in an Aug. 7 e-mail interview. “The central bank has been strengthening its ammunition by increasing reserves.”

India’s foreign-exchange reserves held near an all-time high last week as global investors, who pared holdings of local- currency debt by an unprecedented $8 billion in 2013, plowed back about $14 billion this year, exchange data show. They also purchased a net $12 billion of Indian equities.

Reserves swelled as RBI’s measures along with a landslide election victory in May that swept Prime Minister Narendra Modi to power boosted optimism about a revival in Asia’s third- largest economy.

The shortfall in India’s current account, the broadest measure of trade, shrank to $32.4 billion in the year ended March 31 from an record $88 billion in the previous period, with the RBI’s curbs on gold imports being a key reason. Modi’s government has pledged to reduce the fiscal deficit to a seven- year low of 4.1 percent of gross domestic product this year.

“While the Indian economy is better placed to face any renewed bouts of volatility, there is a need to further augment its reserves by $66 billion to increase its import cover to ten months from the present eight months,” Radhika Rao, an economist at DBS Bank Ltd. in Singapore, said in an Aug. 8 e- mail interview. “Inflation remains high amid risks from weak monsoon rains.”

The monsoon, which brings more than 70 percent of the country’s annual rains, will be 7 percent below average this year due to an El Nino weather pattern, according to the weather office. Inflation in India is also fanned by government support for farmers and subsides to keep food and energy prices low.

“The central bank will maintain its vigil on inflation and is unlikely to cut rates over the next couple of quarters,” Kapur from RBS said. “India needs to maintain rates at the current levels to get a handle over inflation and strengthen its defenses to deal with any exchange-rate volatility as the Fed prepares to raise rates next year.”

(c) 2014, Bloomberg News.