Spectre of Inflation and Quicker US Fed Action May Spook Indian Recovery

Sustained higher inflation in the US may cause serious disruptions in the macroeconomic management of developing countries like India.

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Reputed economists around the world have begun to concede that global inflation is not transitory, as they believed earlier, and threatens to become sticky as economies struggle to return to pre-pandemic levels. In India, the Reserve Bank of India (RBI) speaks of inflation as a risk to full-fledged growth recovery.

In its June Monetary Policy Committee (MPC) assessment, it recognised the threat of inflation from rising global commodity prices, especially in energy, but remained somewhat convinced that manufacturers would not pass on rising input costs to consumers because of depressed demand. But costs are being passed on, making everything from energy, food and metals to paints, clothing, soaps, detergents, chemicals and construction materials more costly.

Last week, in a cartelised move, mobile service tariffs were raised by 20% by three providers. In one stroke the two largest, Reliance Jio and Bharti Airtel, effected an annual additional transfer of Rs 40,000 crore from consumers to corporate coffers. The data consumption honeymoon for the poor and self-employed may be over with another price hike, which is not ruled out. The RBI forecast for the consumer price index next year is over 5%, which is above its comfort level.

The rising price of manufactured goods is captured by the wholesale price index (WPI) at 12.4% in October. WPI has been in double digits for seven months running, largely because of the upswing in global commodity prices. The FAO (Food and Agriculture Organisation of the United Nations) global food price index shows 30% inflation in October 2021 compared to 2020. Coal and gas surged over 200% earlier this year and many see it as sustained “greenflation”. This means higher energy costs may remain sticky as global capital shuns incremental investments in fossil fuel. This is creating an inflationary expectation driven by a longer term supply constraint in fossil fuels. All this is not transitory, as assumed earlier. The macroeconomic implications can be profound.

Also read: What Is Biting Your Wallet: Post-COVID-19, Stretched Supply Chains and High Raw Material Costs

The first shocker came recently when US consumer prices surged 6.2% in October, a multi-decade high. For the whole year, the US Fed sees an inflation rate of 3.5%, way above its comfort level. “It is difficult to predict the persistence and effects of supply constraints, but it now appears that factors pushing inflation upward will linger well into next year,” US Fed chief Jerome Powell said in his submission to a US Congress Committee on Tuesday.

Sustained higher inflation in the US may cause serious disruptions in the macroeconomic management of developing countries like India. With costs of everyday items like food, gas and rent rising quickly, Fed officials have indicated they could hasten the timeline of taper to effect an earlier interest rate lift-off next year. With inflation at a 31-year high, the US central bank’s promise to keep its benchmark overnight interest rate near zero until the labour market recovers is also under threat.

This does not augur well for India, which could experience a “taper tantrum” like the one in 2013. If the US Fed signals quicker withdrawal of liquidity and interest rate hikes, there could be temporary flight of capital from India seeking higher US bond returns, and the rupee could see very jerky downward movements, as in 2013. The rupee is already experiencing some pressures owing to these fears. A sharp and sudden weakening of the rupee can make imports costlier and add to domestic inflation. This might create a vicious cycle, further delaying a recovery in growth and employment.

Even if India does its best, using domestic fiscal and monetary policy tools to stabilise the macro parameters, it cannot escape the bigger storms generated by the Fed’s sharp moves to combat inflation. Global inflation remains the single biggest threat to the recovery of emerging economies, where incomes are already very badly hit by the pandemic.