This post summarises some presentations and papers on managing interest rates in India.
‘Who Moved my Interest Rates’- Dr. Duvvuri Subbarao
https://www.cfainstitute.org/research/multimedia/2016/who-moved-my-interest-rate
Dr. Duvvuri Subbarao explained the challenges and dilemmas he faced as the RBI governor from 2008-2013. This was an extremely rough period for central banks across the world since the financial crisis erupted in 2008 and the taper tantrum erupted in 2013. He talks about how he managed various situations.
The financial crisis of 2008 demanded unconventional things. They had to open a line of credit for mutual funds and NBFCs. Central banks do not do this. However, in the 100-day evaluation of Subbarao’s tenure, the consensus evaluation by the markets and the media was that he handled a very turbulent period with intelligence, professional integrity and exemplary calm.
India recovered from the crisis sooner than most other countries, much sooner than most other emerging markets. But inflation caught up with India and was high, persistent and stubborn. Technically, when confronted with inflation, the central bank has to run a tight monetary policy which means to keep interest rates high. But high interest rates also hurts growth. They had to manage the tension between supporting growth and restraining inflation using one instrument which was the interest rate. However, this time growth was moderating instead of being high and inflation was already high.
Exchange rate dilemma: The taper tantrums which was a collective reactionary panic erupted in 2013 when US Fed Reserve Chairman Bernanke announced that they are going to withdraw quantitative easing. It shouldn’t have surprised anyone because it was known from the beginning that quantitative easing was eventually to be tapered and unwound and withdrawn. But global markets reacted very ferociously to that statement. In India, there was carnage in the external sector and the rupee depreciated by 17%. The rupee took such a beating due to both proximate and deep structural causes.
Subbarao goes on to further talk about how he manages the expectations. On 15th July 2013 he raised the repo rate and the MSF rate with the express intent of restraining the volatility in the exchange rate. But using the interest rate for exchange rate was unusual as they usually do it for purposes of growth and inflation and financial stability. He used interest rate because firstly there was a lot of liquidity in the system and they wanted to restrain it. Secondly, they wanted to send a very strong signal about the RBIs resolve to defend the exchange rate.
Subbarao talks about the dilemmas in public policy that every government official in every country faces. He gives an example where he talks about the backlash against microfinance industry (MFI) in Andhra Pradesh in 2010 due to 3 reasons- usurious rates of interest charged by them, coercive recovery practices and loading poor families with one loan after another making them indebted. RBIs neck was on the block as the supervisor of the MFIs. There was understandably some lapse on the part of the RBI because they put more premium on financial stability that time than on consumer protection. To improve the situation, the governor appointed the Malegam committee which made some wise recommendations. The most important one was to put a cap on the interest rates that MFIs can charge. It was however a difficult decision because if you go back to 1991 or even before that practically every interest rate in the country was regulated by the RBI. Gradually over 20-25 years RBI deregulated the interest rate structure. The last of the interest rates was on the savings bank. In 2010 the RBI relaxed the regulation on the savings bank account where they said that the banks can charge any interest they want. A lot of people said that deregulating interest rates would be Subbarao’s legacy. This was done in July 2010 and then in October 2010 there was backlash against MFI and he was called upon to regulate the interest rate. He regulated the interest rate on MFIs. He deregulated in completely, became a historic figure and then was going to rewrite history by reregulating.
This summary was prepared by Vidhi Agarwal, June 2021
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