D Subbarao at Idea Exchange: ‘RBI should intervene only to curb volatility, let rupee depreciate’

Anil Sasi: In the West, there has almost been a full recovery and the monetary policy intervention is clearly aimed at what can be set right. In India, we are still below the optimal growth path. Is there a tension between how the RBI looks at fighting inflation and supporting the recovery? How does it manage this tension?

The situation in advanced economies is quite different from that of emerging economies, particularly India, because the recovery there is almost complete. They have reached the pre-pandemic levels of output. Of course, they’re caught up with inflation. They don’t have fiscal problems of the type we have. They don’t have the currency problems like us. So comparing advanced economies to emerging economies, particularly India, is misleading. The Finance Secretary has said that we have caught up with the pre-pandemic level of output, 103 per cent of what it was in the April-June quarter of 2019. We should be looking at what the output today is compared to what it would have been in the absence of the pandemic. If you do that, you will realise that our recovery is incomplete. On the other hand, inflation is above the RBI’s target band. So, this is a constant tension for the RBI but particularly acute in a situation like this, where recovery is incomplete and inflation continues to be high.

So far, the RBI has defended the exchange rate. It hasn’t been a very staunch defence, but they have tried to prevent an abrupt fall. Although the rupee has depreciated against the dollar, we can appreciate against other currencies which have depreciated more against the dollar

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Anil Sasi: The exchange rate is acting as a shock absorber. We’ve got significant trade imbalances and the current account deficit is ballooning. A weakness in the rupee can, theoretically at least, restore the balance even though it might be inflationary. But on the capital account side, when you have inflows, doesn’t that somehow go against the run of play?

The RBI is caught up in a classic impossible trinity. The impossible trinity is that no economy, no central bank can, at the same time, have an open capital account, fixed exchange rate and an independent monetary policy. So, RBI is now having to fight the balance between monetary policy and exchange rate management and what degrees of freedom it has. Should it allow the exchange rate to be a shock absorber, allow it to depreciate in order to restore some balance on the trade and current account balances, even if it means it’s inflationary? So, far the RBI has defended the exchange rate. I wouldn’t say it has been a very staunch defence, but they have tried to prevent an abrupt fall. Although the rupee has depreciated against the dollar, we can appreciate against other currencies which have depreciated more against the dollar. The real effective exchange for the currency is still above 100, which suggests that there is some room for depreciation. I think the RBI should allow it to be a shock absorber.

Sandeep Singh: There’s a lot of ambiguity about the pulls from both sides. On one hand, there are concerns about inflation and the rise in interest rates. On the other side, the RBI and the government say we are witnessing a pick-up in consumption and capacity utilisation. What does this mean?

Yes, there are two narratives going around. The economy is picking up from the pandemic lows and consumption has been very strong in the last quarter. Investment has also been strong but manufacturing is weak. Exports do not show the buoyancy of last year but the trade balance is weak, more because of imports than exports. And going forward, as the economy opens up services, there will be consumption. That will drive production and investment. But the contrasting narrative is that the economy was slowing even before the pandemic. If you go back four or five years before 2019-20, you will see the slowing from eight per cent to four per cent. Today, the output is still lower than even that low output level of 2019-20, which indicates some structural problems in the economy. And should there be a recession in the US, it will affect the world economy. Our exports will be hurt and exports have been a big driver of our recovery last year. India’s strong growth story is always correlated with a strong export growth. I’m not very optimistic about export growth prospects.

Pranav Mukul: What do you make of the government’s approach towards cryptocurrency? Since the RBI is bringing its own Central Bank Digital Currency (CBDC), does the government’s move to tighten its grip on private cryptocurrency seem like a disincentive to people from using it and choose the former?

I’m no longer part of official discussions but governments around the world, including our own, are worried about cryptocurrencies because of all the illegal activities that they they can be used for — like money laundering, drug trafficking, terrorist financing and defrauding gullible investors. The Central bank has its own concerns about whether private cryptocurrencies will impair monetary sovereignty or whether they will lead to dollarisation of emerging market economies. So the RBI’s concern is about monetary stability and sovereignty while the government’s concern is about illegal activities. In my own view, the government should regulate cryptocurrencies without banning them. The reason being that if you ban cryptocurrencies, all the activity will go underground, which is much worse for the economy. So it’s better to keep it above ground and regulate it, rather than force it underground. I don’t believe any amount of regulation can fight the cryptocurrency force.

Anil Sasi: Is there a theoretical possibility that with a CBDC, the RBI can end up competing with scheduled commercial banks, at least in the event of an exigency?

We are going to the realm of the unknown at this time, because theoretically, one of the objections or one of the concerns about CBDCs is that they might disintermediate banks and businesses of collected savings, deposits and lending. They’re in the business of financial intermediation. Because if the CBDC comes, everybody has an account with the Central bank, not with the commercial banks. If I had to transfer Rs 5,000 to you, it is not intermediated through our banking system. It goes directly from my account in the RBI to your account in the RBI. If that goes far enough, people will withdraw their deposits from commercial banks and put them in the Central bank. I think that’s far-fetched, at least in the Indian situation, because I don’t see a possibility of the Central bank giving less interest on our deposits. As much as we want interest on our deposit, we will continue to pay some money, put much of our savings in a commercial bank and only put transaction money. What we now keep in our wallets, we will probably keep in our Central bank account. It’s always possible for the RBI to prevent that happening by putting a ceiling on the amount that can be kept in a Central bank CBDC account.

We should be concerned about monopolies, not just because of the cost they will impose on users but the political implications that entails. That’s why there is going to be extra emphasis on regulation. It will ensure they don’t get outsized power in the market

Pranav Mukul: With individual countries getting their digital currencies, does the purpose of something like a SWIFT change in any way?

In some sense, yes. Bilateral exchanges are determined via the dollar, right. For example, if you’re trading with France, we don’t have an exchange rate of the Euro to the Rupee. With Sri Lanka, we don’t have the exchange rate for the Sri Lankan Rupee to Indian Rupee. With CBDCs, it’s quite possible that there will be bilateral exchange. With CBDCs, it is also possible that we’ll be able to trade bilaterally without having SWIFT mechanisms. But I think that has limited potential.

Aanchal Magazine: Given the recent crisis, which has been the stress test for existing policy frameworks, what is your view about the future monetary policy framework? Should it have been revised or is admitting failure a better path?

Before the global financial crisis, the inflation targeting framework was very popular. Central bankers thought that they had discovered the Holy Grail in the form of price and financial stability. The global financial crisis shattered that myth. Now, Central bankers have accepted that an undivided attention on price stability or a numerical inflation target is unwarranted. They must also be looking at financial stability. So there has been a shift from a very dogmatic inflation-targetting to a more flexible inflation targetting.

But then the taper tantrum and the exchange rate crisis also brought in another variable, which is whether you can be focussed just on inflation without taking into account currency movements, especially in emerging economies. In fact, I was quite surprised that when we designed our own inflation targeting framework, there was no leeway allowed for any exchange rate management in that it was an inflation targeting framework with sufficient concern. Should we look at revising our monetary policy framework in the context of this? We should be doing that. But I don’t believe we should move away from an inflation targeting framework, especially in an emerging economy like this. We can tweak our inflation targeting framework, but it’s just too early to give up on that. If, in fact, the RBI is giving up on our inflation targeting framework, that can actually be very damaging.

P Vaidyanathan Iyer: There has been an argument suggesting that if you let the rupee depreciate, there are risks of imported inflation, particularly when our trade deficits are high and we import a lot of crude and other goods.

In public policy, there are no black or white solutions. Always shades of grey. That’s what I always used to say as a Governor. If you are setting interest rates, it’s just a matter of getting all the analysts to tell you what the equation is and what the result is. You could do it but it’s a judgment call. So, the RBI and the government are now joined to make a judgment call on whether they should allow the rupee to depreciate when it is inflationary, but also expansionary in the sense that it supports exports. Or whether they should prevent depreciation of the rupee, because like you said very eloquently, it is inflationary and inflation is a regressive tax. It hurts the poor more. How do you choose? If I was involved in public policy today, I would let the rupee depreciate or allow the fundamentals to have a free play without defending it against externalities. RBI should continue to defend the rupee in order to see that there is no volatility. In other words, they should not engineer the extent of fall but they should engineer the trajectory of fall. But beyond that, the RBI should not be defending it.

P Vaidyanathan Iyer: Over the last 10 years, we haven’t seen the Indian economy grow as expected. Growth has been a particular challenge over the last 10 years. Can India really aspire to grow at double digit growth rates?

What we should be asking is, as much as there are short-term challenges, are there some structural problems that can come in the way of India transcending to a higher growth path of seven to eight per cent? Even if we don’t clock growth like China in double digits, can we at least clock up to eight per cent growth in order to get to a $5 trillion economy as soon as possible and be a developed economy in the next 25 years? That depends both on our domestic and the global economy as well as the geopolitical situation. On the domestic front, let’s not look at the numbers so much as at our growth drivers. If you ask me to give a one word answer to what’s going to drive India’s growth, I would say investment. Because whenever India has grown fast, it has correlated it with high investment.

Mihir Mishra: We did see the first phase of consolidation of banks, which brought down the number of public service banks (PSBs) to 12. Now that was supposed to bring in efficiencies in the banking system. Would you recommend a second phase of consolidation among PSBs?

When they first talked about consolidation of banks, I must admit that I was against it. I thought that it was a distraction. And banks should be focusing on reducing NPAs, increasing deficiency/ efficiency. This consolidation has come in the way of handling or managing consolidation but distracted them from the other jobs. You’re saying that efficiency has improved? I don’t know. But the question we should be asking is, would efficiency have been higher even if there was no consolidation?Efficiencies improved for a number of other reasons as well. So for that reason, I would not recommend the second wave of consolidation.

Soumyarendra Barik: The Data Protection Bill, which was recently withdrawn, had actually gone through a joint committee of Parliament. One of the recommendations that it made in the final report was that India seriously needs to consider an alternative to SWIFT payments. What are the potential issues vis-a-vis privacy on the SWIFT network, and how a home-grown network could solve that?

Replicating a SWIFT requires a lot of governments around the world and their financial systems to become partners. So integrating that is not going to be easy. Admittedly, there are some problems with the SWIFT network, including privacy concerns. But as much as we should ensure those concerns are addressed, the alternatives will be sub-optimal… Whether for bilateral purposes or whether we can have our own SWIFT system, unless India becomes a big player in global trade or global economy, I think it would be difficult for the Indian SWIFT system to gain traction.

Pranav Mukul: How do you look at freebies? There might be two views. One, some of these might be poorly directed, the other that they are the government’s compensation for failing in its social duties. What is the economic answer to this political question?

First, I want to say that in a poor economy like ours, where at least 100 million people live on the borders of subsistence, some safety nets are necessary. And it is incumbent on the government, whether Central or state, to provide livelihood support by way of safety nets. If you had no fiscal constraint, there would be no issue. But we are not in that ideal world. In our world, we have serious fiscal constraints. So we should be spending our money very wisely. The question is, should we be spending it today to finance current consumption? Or should we be spending it to provide a base for production so that it helps future consumption? That is the intertemporal question we should be asking.

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Sandeep Singh: Over the last several years, we have seen a concentration of businesses with the formalisation of the economy. There are emerging monopolies or duopolies and they are getting into all sectors. How do you see that?

The standard micro-economic arguments about monopolies are still valid because they impose costs. Long ago, we used to argue from textbook economics that monopolies are unavoidable because infrastructure is by nature undertaken by the government. It’s a public good so the private sector cannot enter it. But over time, we’ve learnt or seen that what was considered public goods can now be privatised. But that doesn’t mean we will allow private monopolies. I don’t believe that is advisable. The standard arguments against monopolies is that they lead to higher costs, control of the economy by certain business groups and the formation of the politics-business nexus. Those standard arguments are still valid. And we should be sensitive to that.

P Vaidyanathan Iyer: Especially in several sectors — be it telecom, airports, sports — two or three companies are controlling a large percentage of the market share. There seems to be a huge concentration of business power in a few entities…

We should be talking about it more openly and widely. I think the costs of monopolies will still manifest. But we should be concerned about them, not just because of the cost they will impose on users but the political implications that entails. That’s why there is going to be extra emphasis on regulation. Regulation is supposed to ensure that monopolies don’t get outsized power in the market. So it places enormous emphasis on regulators and their independence. It’s something that we should be talking about, something that we should all be aware of and needs a much wider debate.

Why D Subbarao

Served as the Governor of Reserve Bank of India (RBI) for five years (2008-13). Prior to that, he was Finance Secretary to the Government of India (2007-08) and Secretary to the Prime Minister’s Economic Advisory Council (2005-07). He became RBI’s Governor just a week before the global financial crisis in mid-September 2008. An expert on fiscal policy, he led the effort to mitigate the impact of the crisis and initiated economic and financial sector reforms.