RBI needs transparent forex policy, says Subbarao

Using monetary policy tools to fight Rupee slide was toughest decision

Having to fight an attack on the rupee towards the end of his term as Governor (2008-13) at the Reserve Bank of India (RBI), D Subbarao has some advice for the country’s central bank.

His three-point prescription is to be less interventionist, define excess volatility and admit building of reserves is a prime aim.

Subbarao said using monetary policy to defend the exchange rate was one of the toughest decisions he had to make as chief. During the 'taper tantrum' from May till end August of 2013 (his term ended that September), he'd wondered, said Subbarao, about the gap between the stated exchange rate policy and its actions in the foreign exchange (forex) market.

RBI tightened market liquidity through steps such as a quantitative restriction on banks’ access to the repo window (at which they borrowed from the central bank) and open market sales of government bonds. It also raised the Marginal Standing Facility (MSF) rate by two percentage points.

Policy, he felt, should be less interventionist than it has traditionally tended to be. RBI should shift more of the adjustment burden on exchange rate movement to market participants. In this context, it should indicate more clearly what would be considered ‘excess volatility’ that would trigger intervention.

He conceded, though, that doing so would also curtail RBI's flexibility on intervening in the market. Even so, more of rules and less of discretion would, in the long run, yield sustainable benefits by better managing of expectations and minimising of opportunities for self-fulfilling, speculative behavior.

And, said Subbarao, it is time for RBI to admit what is now evident to everyone, that building of reserves is the objective of forex management. RBI should indicate the norms that will determine what is an ‘adequate’ level of reserves, to be more credible in managing policy, he said.

The provocation for the 2013 currency crisis was the ‘taper tantrum’ of the US Federal Reserve. In May that year, then Fed chairman Ben Bernanke said it would reverse its easy money policy and start normalising. The rupee began sliding, to a lifetime low of 68.85 a dollar on August 28, roughly a week before Subbarao’s term was to end. It was 67.03 a dollar on September 4, the day he stepped down.

Global currencies took a beating as investors moved to what they thought as safe investments, including the dollar. India, being one of the ‘fragile five’, was one of the worst impacted. The other four being Indonesia, Turkey, South Africa and Brazil.

The term was coined in August of 2013 by a research analyst at Morgan Stanley, for emerging market economies that had became too dependent on unreliable foreign investment to finance their growth ambitions. India’s forex reserves were low, inflation was high, commodity prices were firming up and fiscal consolidation lacked credibility. Growth prospects were at the bleakest in nearly a decade, Subbarao recalled.