The Inflation targeting (IT) framework, which was formally institutionalised in May 2016, should also have included the “exchange rate stability” clause as monetary policy, exchange rate policy and macroprudential policy are joined at the hip, according to RBI’s former Governor Duvvuri Subbarao.
Under the IT framework, RBI was entrusted with the responsibility of conducting monetary policy in India with the primary objective “to maintain price stability while keeping in mind the objective of growth”. There is, however, no mention of “exchange rate stability.”
“As much as some people use this policy orthodoxy, which is that monetary policy [is] for price stability, macroprudential policy for financial stability and capital flow management measures for rupee volatility, it looks very neat in theory, but doesn’t work in practice.
“So RBI, like any Central bank, has to grapple with this problem and act with all the instruments available to it iteratively. Now, monetary policy and exchange rate policy, indeed, even financial stability cannot be disjointed yet. They’re joined at the hip. So, even though the MPC’s mandate is only delivering on inflation within the target band, I’m sure that they’re concerned about the exchange rate,” said Subbarao, who was RBI Governor from 2008 to 2013.
In an interaction organised by NBIE with economists and analysts, the former Governor said, “In fact, I was surprised when the inflation targeting framework was formulated, they said inflation within this target band (inflation target of 4 per cent with a tolerance band of +/- 2 per cent), subject to concerns about growth. I believe they should have said also subject to concerns about exchange rate stability because exchange rate and inflation are linked.”
He noted that whenever RBI does monetary policy calibration, it looks at the exchange rate’s impact on inflation and on foreign flows.
Subbarao said, “Today, it (rupee depreciation) is an open-ended thing. We don’t know when it’s going to stop. It is, to some extent, beyond the control of the RBI. Just as COVID was beyond the control of governments. So, I don’t think that one short inflow (NRI deposit scheme) is going to solve the problem because we have enough reserves.
“Nobody is going to believe that we’re going to run off $700 billion. So, I think what needs to be managed is fixing policies, structural issues so that continuous flows come in with confidence and with credibility.”
‘Depreciation not all bad’
The former Governor said there is some merit in allowing the rupee to depreciate at this point because it is tracking fundamentals and there is a strong case for being less interventionist in the forex market.
Further, he observed that the current situation is not ripe enough for invoking the Brahmastra (interest rate hike) in defence of the rupee. This can come at a much later stage, as the RBI has enough firepower in terms of instruments available at the moment and sufficient foreign exchange reserves.
Alluding to RBI Governor Sanjay Malhotra’s recent statement that the rupee may be undervalued after the recent depreciation, Subbarao said, “If it’s (rupee) really overshot, it will correct itself. There’s no need for foreign exchange intervention or for capital management measures to correct the exchange rate, which has overreacted, because it will find its way back. So, I believe, there is a strong case for being less interventionist.”
The former Governor’s comment on the rupee comes in the wake of the currency hitting an all-time closing as well as intraday low of 96.83 and 96.95 per US dollar, respectively, on May 20.
The rupee has been depreciating since February-end due spike in global crude oil prices amid the West Asia conflict, which began on February 28, and the continuous FPI-related dollar outflows.
Last week, Arvind Panagariya, Chairman of the 16th Finance Commission, in a series on posts on X, urged RBI not to allow the “psychology” surrounding the rupee breaching the 100-per-dollar mark to dictate its policy response, arguing that depreciation is the appropriate response to a spike in oil-related external pressures.
“Whether the oil shortage is short-lived or long-lived, the right response at this moment is to let the rupee depreciate,” Panagariya said.
Subbarao said, “I think, what needs to be managed is fixing policies, structural issues, so that continuous flows come in with confidence and with credibility.
India growth story
The India growth story is being fuelled by public investment and no private investment is coming up, he said. “So, if domestic private investment is not coming up, even foreign direct investment is unlikely to come in. So, I believe, fundamentally, structurally, there is a demand issue,” added the former RBI Governor.
“Even as we’re growing at 6.5 to 7 per cent, the benefits of that growth are not percolating down, and consumption is not keeping up with growth. That, I believe, is the main reason why foreign investment is not coming in.”
To attract foreign capital, Subbarao suggested that the government must issue a discussion paper on India’s tax regime for foreigners, get feedback and introduce a tax regime and say, “this is it, this is going to be the tax regime for the next five years, and also give about 100 FAQs so that people are aware of how those laws and rules are going to be interpreted.”
Published on May 26, 2026