An idiotic idea that worked
For all policymakers, D. Subbarao’s book is a must-read as it provides them lessons on how to navigate in tough timesAjit Ranade
Former RBI governor D. Subbarao. Photo: Abhijit Bhatlekar/Mint
Rare is the governor of a central bank who pens his memoirs soon after leaving his corner office. Former Reserve Bank of India (RBI) governor D. Subbarao’s bookWho Moved My Interest Rate? is exceptional not just because it comes barely three years after he left Mint Street, but also because of its lucidity and plain speak. It chronicles the turbulent times between 2008 and 2013 when Subbarao headed the RBI.
It was baptism by fire for him, as Lehman imploded within 10 days of his taking charge, leading to the global financial crisis, and much turmoil in India as well. The RBI had to resort to several unconventional actions to protect India from contagion, to calm the markets and ensure some stability. Just as that crisis was ending, the challenge of combating high and persistent inflation in India surfaced. Coupled with that was record high trade and fiscal deficits, and consequent rupee depreciation. To cap it was the rupee panic of 2013 caused by the talk of the tapering of US Federal Reserve’s monetary stimulus. Thus all five years of Subbarao’s tenure were marked by difficult challenges to financial stability, inflation or the exchange rate. His book is a jargon-free primer on the challenges of central banking in a world of turmoil often caused by factors beyond the country’s borders. His emphasis on plain speak was evident even during his tenure, as in his book, as he maintained that his mission was also to demystify the RBI and its functioning.
One of the most interesting, and by the author’s own admission, most difficult to write chapter, is called the Rupee Tantrums. Exchange rate management requires “real-time” decision-making, unlike inflation control. It also entails expectation management, or else currency crisis can be caused merely as a self-fulfilling prophecy.
The currency crisis of 2013, in wake of the taper talk, was unprecedented because India was among only a handful of countries called the “fragile five”, facing acute currency pressure. To stem speculative attacks, India tried everything from hiking interest rates to partial clamping down on dollar outflows. Nothing seemed to be working, perhaps not even an outright ban on import of gold (which thankfully was not tried).
At a recent discussion on the book, incumbent RBI governor Raghuram Rajan, who was then an officer on special duty in the RBI, recounted that among all the ideas in 2013 was also an “idiotic one”. This was to entice dollar inflows into India, by offering subsidized protection against rupee depreciation. This would provide comfort to foreign investors. The forward cover (or full insurance cost) on the rupee-dollar was about 7% per annum, of which the RBI could cover 3.5%. Assuming an inflow of $10 billion, over a three-year period, this could easily cost the RBI and the exchequer between Rs.10,000 crore and Rs.20,000 crore. Seemed like a crazy and expensive idea. But slowly it gained traction, since if the rupee didn’t stabilize, the nation would lose much more by way of a higher import bill. For instance, a Rs.4 fall on an import bill of $400 billion leads to an extra outgo of Rs.1.6 trillion. So, reluctantly, Rajan signed on to the crazy idea. And lo and behold, this turned out to be the prize-winning trick. The nation received more than $30 billion. Not only did the rupee stabilize and strengthen, but three years later, the RBI ended up making a profit on its forward deals. It had shored up adequate reserves in forward purchases to provide for the repayment that will be due next month. So, an idiotic idea worked because it was an intelligent gamble, which paid off.
It was Subbarao’s magnanimity to let Rajan make the announcement of this dollar scheme in 2013. And Rajan, who got much credit for saving the rupee, was humble and gracious to admit that he initially thought the idea was idiotic. The noble actions don’t just speak about the personalities, but are also the hallmark of the institution and its maturity, which at 81, is older than the republic!
One lesson of this “idiotic idea” can be considered for setting the basic rate for the goods and services tax (GST). What if we consider a lower GST rate, say 15%? The fear of lower tax collection can be offset by the reimbursement, or insurance scheme (much like the RBI had offered insurance against rupee depreciation). So, states that might have a revenue shortfall will be fully reimbursed by the centre. Given the buoyancy in collection, and an extra 1.5% growth in gross domestic product, we might all be in for a pleasant surprise. This is just like how the RBI surprisingly garnered three times the dollars it had anticipated. This low GST rate too will provide a post-facto vindication of a gamble that works.
It is an intelligent gamble, whose odds improve much like a self-fulfilling prophecy. Undertaking the gamble itself improves its odds. In a broader sense, much of policymaking involves a gamble, but if done intelligently, can assure desired results. If the reimbursement to states is avoided because it might breach the fiscal deficit target, that too is a gamble worth taking.
Subbarao’s book is a must-read for all policymakers, as it provides them candid insights and useful lessons on how to navigate tough and unpredictable times. He was amused to learn that Who Moved My Interest Rate? is sometimes kept in the ‘self-help’ shelves of bookstores. Maybe that is just as well, as central bankers will testify!
Ajit Ranade is chief economist at Aditya Birla Group.
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