Interestingly, inflation in United States and the organization for Economic Co-operation and Development (OECD) countries is higher than it is in India. This has happened for the first time in living memory. The cause of inflation in US is not because of higher energy prices (it is an oil exporter), but due to massive economic stimulus to combat Covind—19. As a result, the Federal Reserve has been forced to start raising interest rate to moderate inflation.
The sharp increases in the US have led to an outflow of funds from India, seriously impacting the exchange rate and causing the rupee to fall an all time low against dollar. This puts Reserve Bank of India in a difficult position. Raising interest rates tends to curb demand even though aggregate demand is still soft. In fact, raising interest will delay the start of the capex cycle, which will affect the growth prospects of the economy, making the cure worse than the problem.
The basic equation for debt servicing is that if the normal growth rate is higher than interest rate, the country can service its debt. If the growth rate falls below the level of interest rate, servicing the debt becomes much more painful and requires reallocation in expenditure away from productive purposes. However, the sharp outflow of funds will put pressure on RBI which had led it to raise rates to support the rupee. Navigating this situation is going to require deft handling and out of the box responses.
To address inflation in India today, the need of the hour is to control oil prices, both by buying oil cheaply from Russia and reducing taxes on oil to contain the prices the consumer pays. However, lowering taxes will pressure on fiscal balance. To control this, the disinvestment programme cannot slacken. The fall in global indices will make this more problematic politically as the prices realization will be lower. However, the alternative will be worse, and so, disinvestment must not stall. Waiting is unlikely to help, as prospects for global economy are fading with the expectation of a recession in Europe and the US rising, and zero—Covid19 policy in China has reduced its growth rate. The China West tension is unlikely to dampen its economy’s prospects further in the medium-term. So, delaying disinvestment programme in the hope that markets recover quickly may not be prudent. (IPA Service)
INDIAN POLICY MAKERS FACING BIG TEST IN DEALING WITH INFLATION IN CURRENT FISCAL
GLOBAL ECONOMIC OUTLOOK MAKES THE TASK OF STABILISATION TOUGHER
Harihar Swarup - 2022-07-09 10:51
The impact of the ongoing Russia—Ukraine war on energy and commodity prices has caused great global economic turmoil. Some countries are facing food shortage and all oil-importing countries have been adversely affected. The invasion has come at an unfortunate time for India. Just when we all dealt with our double balance sheet problem and our corporate and financial sector balance sheets started to rise, the war affected the capital investment cycle in India. It is important to recognize that inflation in India is not the result of increased aggregate demand — capacity utilization is still, on average, around 70% — but because of higher energy prices and supply chain disruptions. Thus, interest rate hikes cannot curb it.