Correcting rupee against fundamentals ultimately futile, says RBI's ex-guv Subbarao

DUBAI: Trying to correct the rupee to a level that does not reflect economic fundamentals through costly, distortionary short-term measures will ultimately prove futile, former Reserve Bank of India governor D Subbarao said.

“The RBI should allow the rupee to find its level while managing the trajectory, rather than trying to control it at a particular level…(which) would be distortionary and costly, and it will eventually return to its fundamental level,” Subbarao told ET in an interview.

The rupee will strengthen when the country attracts durable capital flows based on fundamentals rather than “borrowed resources,” he said.


His remarks come as the rupee recovered nearly 2% from near-record lows of 96-97 per dollar last week after the central bank introduced measures to curb dollar demand and speculative bets against the currency.

The package included a special USD window for public-sector oil marketing companies (OMCs), a Foreign Exchange Risk Reserve (FERR), tighter forex-derivative restrictions, an OMO (open market operation) sale and higher daily CRR (cash reserve ratio) maintenance requirements.

“The RBI’s macroprudential measures last week helped the rupee recover a bit, but the most important question is, why is the rupee falling?” Subbarao said. “Ultimately the exchange rate is a function of market expectations and demand and supply. Correcting the rupee against fundamentals will be ultimately futile.”

On the special Foreign Currency Non-Resident (Bank) (FCNR(B)) dollar deposits scheme, which mobilised about $133 billion by the window close on August 31, he said, “The market knows that these are borrowed resources and it is a costly proposition.”

Need for tax reforms to attract foreign investment

Subbarao, who served as RBI governor from 2008 to 2013, rejected the perception that the rupee is falling only because of current account pressures coming from oil prices and high import bills.

That is the proximate cause, but there are deeper structural issues, he said. “Capital outflows have been a structural cause of the rupee’s depreciation,” he added.

“One of the complaints I hear from international investors who look at opportunities across the world is that India is less predictable and more arbitrary in its regulation and interpretation of tax laws,” Subbarao said. “So, we need to do perception management and reputation management, and bring predictability towards taxation and regulatory measures.”

He called for a tax structure comparable with that of other major economies.

“We cannot expect investment to come to India simply because we are a fast-growing economy. Investors also want assurances, and the taxation regime is important,” he said.

His comment comes amid mounting calls for the rollback of long-term capital gains tax and securities transactions tax.

While the government has cancelled withholding tax and capital gains tax on foreign investment in government securities, “the question now is whether these measures should be extended across the board,” Subbarao said.

In June, the government eliminated the 20% withholding tax on interest and the capital gains tax on Indian government securities for eligible foreign investors.

Subbarao noted that pull factors like global investment opportunities in AI, advanced manufacturing, semiconductors, climate change and other areas have also attracted investment away from India.

Monetary policy and global economic outlook

Speaking to ET on the sidelines of the SuperReturn Middle East event, Subbarao also said monetary policy is unlikely to be effective in controlling supply-driven inflation such as food and fuel.

The RBI raised the benchmark repo rate by 25 basis points to 5.5% this month amid rising inflationary pressures. Wholesale price inflation rose to a 30-month high of 11.4% in September under the new series and a 49-month high as per the old series, mainly led by food and fuel.

“Monetary policy is most effective when inflation is triggered by demand shocks and less effective against inflation driven by supply shocks,” Subbarao said. “On the other hand, it can be costly in terms of lower growth.”

He cautioned that if supply shock persisted, people’s inflation expectations can become unanchored and can drive inflation, which can then become generalised.

On the global economic outlook, Subbarao said the world economy is approaching the limits of its resilience. “I think things will get worse. We expected them to deteriorate earlier, but the impact has so far been contained because of various safeguards. If, as the International Monetary Fund has indicated in its latest assessment, those safeguards are reaching their limits, these factors will have a negative impact on the economy,” he said.

On India’s growth performance, he said a 7.8% growth is not translating into enough productive jobs as gains are unevenly distributed across the economy. “While the economy has grown, the benefits have not been widely shared,” Subbarao said. “As a result, people are not experiencing the benefits of growth as widely as they should and jobs are not being created in sufficient numbers.”