Reserve Bank of India Governor D Subbarao has attributed the sharp depreciation of the rupee over the last three months to the government’s failure to take care of domestic structural factors such as a high current account deficit (CAD), which is well above the “sustainable level”.

Delivering the Nani Palkhivala Memorial Lecture – his last public speech as the RBI Governor in Mumbai today, Subbarao said India was earlier able to finance the CAD because of the easy liquidity in the global system.

“Had we used the breathing time that this gave us to address the structural factors and brought the CAD down to its sustainable level, we would have been able to withstand the ‘tapering’ of the ultra-easy policy of the US Fed. In the event, we did not. We therefore made ourselves vulnerable to sudden stop and exit of capital flows driven by global sentiment; the eventual cost of adjustment too went up sharply,” Subbarao said. The title of his lecture was – “Five years of leading the Reserve Bank; looking ahead by looking back”.

Subbarao said CAD could increase substantially even in a low growth environment if supply constraints impacted both growth and external trade as has been the case with us. The only lasting solution to India’s external sector problem, he said, was to reduce the CAD to its sustainable level and to finance the reduced CAD through stable, and non-debt flows.

“Reducing the CAD requires structural solutions - RBI has very little policy space or instruments to deliver the needed structural solution. They fall within the ambit of the government. Structural adjustment will also take time. In the interim, we need to stabilize the market volatility, a task that falls within the domain of the RBI,” he added.

He pointed out that RBI had stayed trur to the policy that it is not its job to target a level of exchange rate. “Our efforts over the last few years, particularly the last three months, have been to smoothen volatility as the exchange rate adjusts to its market determined level so as to make the near-term cost of adjustment less onerous for firms, households and banks,” he said.
    

Dismissing criticism that RBI’s policy measures have been confusing and betray a lack of resolve to curb exchange rate volatility, Subbarao said the only gap could have been its failure to communicate the measures more effectively.

RBI’s capital account measures, he said, were aimed at encouraging inflows and discouraging outflows. Also, the central bank tightened liquidity at the short end to raise the cost of short-term money so as to curb volatility. At the same time, RBI wanted to inhibit the transmission of the interest rate signal from the short end to the long end as that would hurt flow of credit to the productive sector of the economy. “So, we instituted an Indian version of “Operation Twist”.

The RBI Governor dwelt at length on the central bank’s autonomy and said there had been a lot of media coverage on policy differences between the government and the RBI. “Gerard Schroeder, the former German Chancellor, once said, “I am often frustrated by the the Bundesbank. But thank God, it exists.” I do hope Finance Minister P Chidambaram will one day say, “I am often frustrated by the Reserve Bank, so frustrated that I want to go for a walk, even if I have to walk alone. But thank God, the Reserve Bank exists.” (Business Standard)