Ex-RBI chief: Look through oil shocks, act only if they last

Dubai: Central banks should look through oil shocks at first and tighten only when the shock persists, says Duvvuri Subbarao, former Governor of the Reserve Bank of India. In an interview with Gulf News, he outlined the playbook that global economies should resort to when faced with supply shocks.

Monetary policy works on demand, growth and exchange rates, so it does little against a supply shock. “Fighting a supply shock with monetary policy can cost in terms of growth and employment. But that response or that position is good only for some time. But if the supply shock persists, then inflation expectations can get entrenched, and inflation can get generalized. At that time, it is important for a central bank to respond to the situation through monetary policy,” he says.

The timing couldn't be more apt. Crude oil prices took a sharp plunge of over 8 per cent on November 2, as US and Iran signaled willingness to pursue peace talks. This brought global benchmark near $105 a barrel after breaching $115 a barrel just 3 days earlier. So, simmering hostilities are keeping the market on edge.

The calculus changes when the shock lasts. “Premature tightening can hurt growth. Delayed tightening can unleash inflation.” Picking the moment is “a matter of judgment,” he adds.

Taking cues from the Fed

The Fed movement adds pressure. India connects to global finance through both its current and capital accounts, he observes. A stronger dollar and a narrower interest rate gap with the US feed into the rupee. The RBI faces the classic “impossible trinity” dilemma: no economy can combine independent monetary policy, an open capital account and a fixed exchange rate. Subbarao thinks the central bank has handled it well.

He separates today from the 2013 taper tantrum, when he ran the RBI. The rupee faces heavy pressure now, he says, but not a crisis. In 2013, growth was slowing and inflation was high. Fiscal and current account deficits were large, and reserves were thin. Today, growth is robust, the current account deficit is under control, fiscal consolidation is on track and reserves are large.

What UAE family offices should price in

Asked whether higher rates and a softer rupee could hurt GIFT City and DIFC as a capital corridor, Subbarao urges caution. Investors judge interest and exchange rates across several cycles, he argues. For long-term prospects, they are “relatively small variables.”

His advice to UAE family offices is direct. Price in India’s long-term prospects, not today’s exchange rate and interest rate. He points to an expanding middle class and workforce, digital infrastructure, entrepreneurship, manufacturing capacity and services exports.

The same horizon applies on both sides of the corridor, he says. DIFC and GIFT City, and the UAE and India more broadly, should keep the long view in mind.