Lessons from a departing chief

Last Thursday, D Subbarao, outgoing governor of the Reserve Bank of India (RBI), explained the rationale behind many of its many decisions in the past five years and reiterated some of the central bank’s basic policies.

The speech deserves the attention of exporters and importers, besides policy analysts and other stakeholders in the economy, for the important issues it deals with so lucidly.

The governor was emphatic that it was the avowed policy of RBI not to target a level of exchange rate. And, that its efforts over recent years, particularly the past three months, had been to smoothen the volatility as the exchange rate adjusted to its market-determined level, so as to make the near-term cost of adjustment less onerous for companies, households and banks.

In response to criticism that RBI’s policy measures had been confusing and betrayed a lack of resolve to curb exchange rate volatility, he reiterated RBI’s total and unequivocal commitment on the latter.

Such a strong articulation by the outgoing chief might make it somewhat difficult for the incoming governor, Raghuram Rajan, to make a quick departure from the established policy, although the latter’s merits are open to question. Exporters and importers would be justified in assuming that the fund managers whose sole focus is on making profits through speculation will continue to influence exchange rates disproportionately, with RBI only helping them do so in an orderly manner. They have no option but to learn and master the complexities of the various hedging instruments available and learn to take on the many bankers better placed to sell various sophisticated derivatives without parting with all the necessary information about the risks involved.

Exporters should note the governor’s statement that the only lasting solution to our external sector problem is to reduce the current account deficit (CAD) to a sustainable level and to finance the reduced CAD through stable and, to the extent possible, non-debt flows. The finance minister had also emphasized that the CAD must be reduced to $70 billion and unless exports were increased, the deficit could not be reduced. In recent days, the rupee has not only gone through significant correction but has clearly overshot and become undervalued. If the incoming RBI governor does not allow the rupee to get overvalued again, exporters will be able to quote competitive rates to buyers.

Sure enough, some buyers will seek negotiations on the basis of current exchange rates and the rupee depreciation might not give exporters a windfall profit. But they will be surely able to bag orders, keep their machines running and better utilise their capacities. What they must do is seek a slightly undervalued rupee, rather than more subsidies and an overvalued rupee.   

As the governor said, the exit of capital flows, driven by global sentiment, has pushed up the cost of adjustment. However, it has also presented an opportunity to exporters and domestic manufacturers for coping better with the competition. They must exploit the window of opportunity before the spiralling effects of a weak rupee and consequent inflation erodes their competitiveness again.

email: tncr@sify.com