Many observers were surprised by RBI's recent rate hike. It appears to make no sense in terms of where the economy is going. As Ila Patnaik points out in an excellent piece in Indian Express today, it isn't hard to understand what RBI did, but you have to shift your mindset to a modern framework of open economy macroeconomics.
With a pegged exchange rate, and with a de facto open capital account, RBI doesn't actually have much autonomy to run a monetary policy that is crafted to suit India's interests. The weapon of monetary policy is getting used up to deliver low currency volatility, when it could instead be used to deliver low GDP volatility. So even though it just doesn't fit in the immediate context of Indian macro, RBI is responding to the interest rate hikes of the US Fed.
Some people think it's obvious that when the Fed raises rates, every country has to also do so. But as theory and evidence show, strong correlations of monetary policy across countries only happen when you peg or fix. Frankel, Schmukler and Serven have an excellent 2002 NBER paper on the loss of monetary policy autonomy for countries that fix/peg.
Open economy macro is a new field in India, and there isn't much out there. So here are some pointers to work in this field. What is India's exchange rate regime; why do we have such a huge reserves accumulation? Ila solved this in 2003. Does this hurt the implementation of monetary policy? I.e., is there `enough' openness on the capital account for a pegged exchange rate regime to come at the price of monetary policy autonomy? Ila did this in India's experience with a pegged exchange rate, which appeared in India Policy Forum (Brookings Institution & NCAER), Volume 1, 2005 (Here's a WP version). Finally, how can one interpret India's story with capital flows from this framework? Ila and I did a paper India's Experience with Capital Flows: The Elusive Quest for a Sustainable Current Account Deficit which is forthcoming in an NBER book.