RBI Should Allow Rupee to Depreciate, Utilize Liquidity Tools to Combat Inflation: Duvvuri Subbarao

Former RBI Governor Duvvuri Subbarao Calls for Caution in Monetary Policy

Former RBI Governor Duvvuri Subbarao has urged the central bank to exercise caution in its monetary policy, suggesting that it allow some further depreciation in the rupee to absorb external pressures. Subbarao, who served as RBI Governor between 2008 and 2013, believes that the monetary policy should only be used as a "last resort" to defend the exchange rate.

The rupee has been depreciating due to geopolitical uncertainty and the West Asia crisis, touching a lifetime low of 97.15 against the US dollar earlier this month. According to data compiled from market sources, the rupee has depreciated by 5% since the start of the West Asia crisis, 6.1% since the beginning of the year, and over 10% in one year.

Subbarao emphasized that managing expectations is crucial in stabilizing the exchange rate during times of pressure. He noted that exchange-rate crises are ultimately crises of confidence, and that policymakers must act decisively without appearing panicked or defensive. Effective communication is key, as investors, importers, and households may behave in ways that exacerbate the situation if they believe the rupee will weaken further.

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The Monetary Policy Committee has a challenging task ahead of it, with limited room to maneuver. Subbarao pointed out that lowering interest rates to support growth could aggravate inflation and intensify exchange-rate pressures, while aggressive rate increases could hurt economic activity and impact GDP growth.

The RBI's Monetary Policy Committee will meet between June 3 and June 5 to decide on the policy rate. The current repo rate stands at 5.25%, having been reduced by 1.25% since last year to aid growth. Subbarao believes that the preferable approach for the RBI at this stage would be to wait and assess whether inflationary pressures become broader through the system, rather than immediately resorting to policy rate hikes.

If inflation starts to harden meaningfully, Subbarao suggests that some actions may become necessary for the RBI. In that case, the tightening could first come through liquidity management rather than outright rate hikes.

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