Subbarao's legacy: He repeated history as farce and tragedy

In exactly two weeks, Duvvuri Subbarao will become the 22^nd ex-Governor of the Reserve Bank of India. He would have liked a better farewell from the rupee, which at the rate of its current decline, may well hit Rs 70 to the dollar by September 5. But circumstances have rarely been kind to the departing RBI Governor. Recall how the global economy went into meltdown following the spectacular collapse of Lehman Brothers on September 15, 2008, just ten days after Subbarao had occupied the hot seat in Mint Street.

Subbarao has some harsh critics. The eminent economist, Arvind Panagariya, has already pronounced Subbarao's tenure as the "worst era of performance by an RBI Governor." The dire macroeconomic situation - stalling growth, persistent inflation, collapsing currency - could well be the evidence supporting Panagariya's view. However, blaming Subbarao for the latest macroeconomic crisis would be as unfair as blaming him for the negative impact of the global meltdown on India. The fact is that no other Governor in recent history has faced such dire crises (not of their own making) at both ends of their tenure - Bimal Jalan dealt with the Asian crisis at the start of his tenure. Subbarao's record must be judged in this unusual context. Unfortunately, even then, he will be remembered as the RBI Governor who picked the wrong battles to fight.

Subbarao's aggressive use of interest rates to tame double-digit inflation (between March 2010 and September 2012) had only a limited impact on price rise, but succeeded in choking the growth rate of the economy. Reuters

There are two lessons Subbarao should have imbibed from the tenure of his predecessor, fellow Andhra Pradesh IAS officer, Y.V. Reddy. First, interest rates are a very crude instrument to fight inflation that is caused primarily by the high prices of commodities - either because of supply constraints in agriculture or because of high international prices of some items like oil. Second, the 'Impossible Trinity' is the one textbook economic theorem, which actually applies to the real world. It is impossible to have free capital flows, an autonomous monetary policy and a managed exchange rate at the same time. In not learning the lessons from his predecessor's history, Subbarao was destined to repeat history, as farce and tragedy.

Subbarao's aggressive use of interest rates to tame double-digit inflation (between March 2010 and September 2012) had only a limited impact on price rise, but succeeded in choking the growth rate of the economy. The UPA Government played its part - policy paralysis and fiscal profligacy hit growth and fuelled inflation but Subbarao's interventions only compounded the problem, rather than easing it. Y.V. Reddy had done something similar beginning in late 2007 and leading up to the crisis of 2008 when he hiked interest rates to combat inflation (that was borne out of high international commodity prices; oil was touching $150 per barrel). So when the global crisis hit, Reddy's interest rate policies only exacerbated the slowdown. There is one big difference between 2008 and 2013. In 2008, the global meltdown also led to a steep fall in inflation in India as the global prices of all commodities including oil collapsed. The fall in inflation then made Subbarao's task as the new RBI Governor much easier. In 2013, the economy has stagflation, with falling growth and high inflation.

Subbarao's attempts at exchange rate management have been equally disastrous for the economy. His desperate measures in the last fortnight, no doubt encouraged by the Finance Ministry, have only destroyed confidence. They have also led to an upward pressure on interest rates at precisely the time rates need to come down to boost a growth rate that has fallen to sub-5 percent levels. Instead of rushing to prevent the decline of the rupee (a market-based adjustment to fundamental economic problems, like a large CAD) with capital controls and interest rate/liquidity instruments, Subbarao should have let market forces work. Reddy was caught out in 2007-08 trying to do the opposite - prevent the rupee from appreciating. But Subbarao clearly hadn't learnt from the doomed farce if his predecessor.

Subbarao did not create the rupee crisis, but his mismanagement of it will define his legacy, just like the misuse of interest rates will also be a black mark.

If only Subbarao had picked other more worthwhile battles to fight. For example, he could have countered conventional wisdom and done more for liberalization of India's financial system -structurally, interest rates are just too high for an emerging economy like India which needs cheaper finance to grow quickly. In a different example, Subbarao could have tried to reform the RBI, by allowing a separate Independent Debt Management Office. That would have ended RBI's conflict of interest on managing the Government's debt and setting interest rates. He could also have made the setting of monetary policy more transparent - RBI is one of the few major central banks in the world that doesn't really explain in any detail to the public why it is taking certain decisions. All of these would have been battles worth fighting and winning. They would have left a positive legacy.

It would have been so much better than walking into the sunset as a tragic figure: the one RBI Governor who fought a losing battle.