Former Reserve Bank of India (RBI) Governor Duvvuri Subbarao, on Thursday, said that low interest rates and surplus liquidity in the system could potentially disrupt the financial stability, as people with surplus money are looking for higher yields and investing in riskier assets. 

“The RBI has made extraordinarily easy policy in the last two years since the Covid pandemic affected the country. It was very necessary and the RBI took the right stance and has been instrumental in keeping the economy going,” said Subbarao, adding, “but the concern today is that the low interest rates and the enormous liquidity could potentially disrupt financial stability”. 

“Because there is too much money going around in the system. Since people don’t have opportunities to get appropriate returns, they start searching for higher yields. They are going into riskier and riskier assets and that could destabilise financial stability,” he added. 

He was delivering the keynote address titled, ‘Policy-making Dilemmas During Turbulent Times’, at the 12th annual Great Lakes-Union Bank Finance Conference, organised by Great Lakes Institute of Management, Chennai. 

The Monetary Policy Committee (MPC) of the RBI unanimously voted to keep the policy rates repo and reverse repo rates unchanged at 4 per cent and 3.35 per cent, respectively. 

Referring to today’s policy move, the former RBI Governor said that the central bank has kept a pause on the policy stance, thereby trying to maintain the balance between growth and inflation. “This was always a challenge for any central bank even in normal times and even a big challenge during a crisis like the current situation,” he added.

Subbarao said the challenge for central banks and the RBI is to juggle between maintaining price stability, supporting growth and employment and also to preserve financial stability.

“The dilemma for the RBI today, as it was all through my time, was how to support growth and maintain low steady inflation. Because the mandate of the RBI is to deliver price stability as well as to support growth. So, with one instrument (overnight repo rate), the RBI serves two objectives of combating inflation and also supporting growth,” he added. 

‘RBI on right track’

To a question on what he would have done if he was the RBI Governor today, Subbarao replied that what the RBI is doing now is the right thing to do and he would have done exactly the same thing.

The former central bank Governor said managing the global financial crisis, managing monetary policy, managing communication, managing the exchange rate and managing regulation are the five major dilemmas he faced as Governor. 

Subbarao said markets pay very close attention to what the central bank says and look at every phrase, every nuance of them. “They notice both verbal language as well as body language,” he added. 

“Communication is a very potent tool. Until recently, central banks have been reticent about using communication as a policy tool. But over the last 15 years there has been a shift in that orthodox approach,” he added. 

Related Topics
comment COMMENT NOW