RBI, plug into other central banks

The minutes of the US Federal Reserve‘s December meeting released last Wednesday point to a faster-than-expected rise in US interest rates to fight inflation. The news sent stocks falling, bond yields rising and cryptocurrencies sliding. With the Fed declaring that it may trim its balance sheet (that will suck up liquidity), the inflation threat is real. The minutes also indicate that once the process begins, the appropriate pace of balance sheet runoff would likely be faster than it was during the previous normalisation episode in October 2017. So, central banks and markets should not be in a state of denial that the dovish stand will continue. RBI’s stated position that its ‘monetary policy stance is primarily attuned to the evolving domestic inflation and growth dynamics’ is getting tested now. If its policies continue to be conditioned by the Indian economy’s needs, and not by global developments, RBI may end up chasing, rather than guiding, the market. Financial markets are integrated. So, RBI must act in line with other central banks, not stand in isolation.

A tighter Fed poses the risk of capital outflows from India, along with the associated worries over exchange and interest rates. The rupee may depreciate, but this would correct the strength in the real effective exchange rate over the years, and improve the competitiveness of Indian exports. Imports will become costly. RBI must assess the rupee depreciation against the risk of imported inflation. It should work together with GoI to maintain macroeconomic stability and prepare the markets to prevent any undue volatility.

Crude prices have come down. But inflation is still driven mainly by input prices, rather than excess demand. Containing inflation calls for fixing supply bottlenecks and avoiding curfews. Most states have imposed curfews due to worries over Omicron‘s spread. Supply chains will get disrupted once again and derail economic recovery. States must focus on pandemic control, not lockdowns. GoI must also spend more to speed up economic activity to absorb any shocks.


Leave a Reply

This website uses cookies. By continuing to use this site, you accept our use of cookies.