Dubai: Trying to correct the rupee to a level that does not reflect economic fundamentals through costly, distortionary short-term measures will ultimately prove futile, former Reserve Bank of India governor D Subbarao said.

"The RBI should allow the rupee to find its level while managing the trajectory, rather than trying to control it at a particular level...(which) would be distortionary and costly, and it will eventually return to its fundamental level," Subbarao told ET in an interview.

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The rupee will strengthen when the country attracts durable capital flows based on fundamentals rather than "borrowed resources," he said. His remarks come as the rupee recovered nearly 2% from near-record lows of 96-97 per dollar last week after the central bank introduced measures to curb dollar demand and speculative bets against the currency.

The package included a special USD window for public-sector oil marketing companies (OMCs), a Foreign Exchange Risk Reserve (FERR), tighter forex-derivative restrictions, an OMO (open market operation) sale and higher daily CRR (cash reserve ratio) maintenance requirements.

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"The RBI's macroprudential measures last week helped the rupee recover a bit, but the most important question is, why is the rupee falling?" Subbarao said. "Ultimately the exchange rate is a function of market expectations and demand and supply. Correcting the rupee against fundamentals will be ultimately futile."

On the special Foreign Currency Non-Resident (Bank) (FCNR(B)) dollar deposits scheme, which mobilised about $133 billion by the window close on August 31, he said, "The market knows that these are borrowed resources and it is a costly proposition." Need for tax reforms to attract foreign investment.

Subbarao, who served as RBI governor from 2008 to 2013, rejected the perception that the rupee is falling only because of current account pressures coming from oil prices and high import bills. That is the proximate cause, but there are deeper structural issues, he said. "Capital outflows have been a structural cause of the rupee's depreciation," he added.

"One of the complaints I hear from international investors who look at opportunities across the world is that India is less predictable and more arbitrary in its regulation and interpretation of tax laws," Subbarao said.