India’s Inflation Issues and the RBI

The IMF World Economic Outlook for July 2022 predicted surging commodity prices and broadening price pressures which can cause inflation to reach 6.6 percent in 2022 in advanced economies and 9.5 percent in emerging markets and developing economies.

Inflation is the talk of the town across all economies. The presence of repeated shocks throughout the years stemming from the outbreak of the pandemic and the most recent Ukraine-Russian conflict has resulted in an inflation crisis that was previously unheard of in the present, thus posing a danger to global macroeconomic stability. As a result, countries around the globe are promoting monetary policy tightening measures to remove liquidity from the economy and push away the threat of an inflation crisis.

To counter inflation in the Indian context, the monetary policy committee in August increased policy rates and has called for a narrowing policy rate corridor. This implies that loans now have a higher rate of interest making them more costly thus deterring borrowing and tightening liquidity in the Indian economy. For the month of August, the Monetary Policy Committee has maintained a stance of “calibrated withdrawal of accommodation” which again implies that the RBI will be slowly reducing liquidity in the economy. This was done during the pandemic, to ensure that the liquidity target is maintained. At the same time, supporting growth over a calibrated period.

India is quite wary of inflation; it is evident when the inflation targeting framework was put forth and adopted in 2016. In this framework, headline CPI inflation is focused on a target of 4 percent with a tolerance band of +/- 2 percent around it. To ensure this target the monetary policy committee convenes multiple times a year to take decisions through a voting policy that can make this target viable in India. However, the maintenance of this inflation target does not take precedence during black swan events like a global pandemic. During the first wave of the pandemic, India went from a 4% inflation level to 6.2 percent. This was because of the various schemes implemented to pump liquidity into the economy to support the Indian population. Inflation would have been eventually moderated and eased to 5.5 percent in 2021-2022 in the following year and was projected to reduce even further to 4.5 percent in 2022-2023. This aspect did not happen due to another unprecedented event of war. Russia - Ukraine has created global havoc in supply chain logistics, raising food and fuel prices and resulting in a sticky high inflation trend. As a result, the RBI has projected a headline CPI inflation for the financial year 2022-2023 to average 6.7 percent.

What we can anticipate…

This target is subject to change if any other global catastrophe is imminent. Thus, dealing with the inflation crisis has become a complicated issue. With the presence of global spillovers together with the fact that India is yet to recover from the losses of the pandemic while working with a deteriorating balance of payment and multiple deficits, the risks to growth are plenty. Furthermore, the hardening of liquidity should be dealt with carefully to prevent issues of stagflation or recessionary states. A strict tightening can create economic states that could mirror economies before the onslaught of a severe recession. India’s central bank and monetary policy committee thus have to be very stringent in their decision-making to protect the Indian economy. The Indian central bank has evolved from a “lender of last resort” to a “defender of the first resort” by managing expectations and ensuring economic equilibrium. All eyes are on RBI, on how it will govern the Indian economy during these troubling yet pressing times.