The Reserve Bank of India (RBI) has said that the Indian economy can escape the global inflation trap if the moderation in commodity prices witnessed in recent weeks endures, alongside an easing of supply-chain pressures.
“The biggest source of relief is from inflation coming off its recent peak, albeit at an elevated level still,” the central bank has said in its latest ‘State of the economy’ report. Nonetheless, the signs of its generalization and the potential unhinging of inflation expectations have elicited a preemptive and front loaded monetary policy response, the RBI said.
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RBI Governor Shaktikanta had recently said that inflation was likely to “ease gradually in the second half of 2022-23, precluding the chances of a hard landing in India”. Prior to that, Deputy Governor Michael had noted that there were signs of inflation peaking, and harsh policy may not be needed to contain price pressures.
If the commodity-price moderation seen in recent weeks continues, along with an easing of supply-chain pressures, the worst of the recent inflation surge will be left behind, and the economy can escape the global inflation trap and enjoy the fruits of the ebullient supply response that is taking place, the RBI report said.
While the US inflation rate shot up to a 41-year high of 9.1 per cent in June, India reported a retail inflation of 7.01 per cent in June, down marginally from 7.04 per cent in May and 7.79 per cent in April.
“The international environment is hostile and hence, close and continuous monitoring of the widening trade deficit and portfolio outflows is warranted, notwithstanding strong reserve buffers, moderating external debt, and a fairly valued exchange rate that has wilted less in the face of the monotonic strengthening of the US dollar than many peers,” the report said.
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Moderating inflation
While US inflation shot up to a 41-year high of 9.1 per cent in June, India reported a retail inflation of 7.01 per cent, down from 7.04 per cent in May and 7.79 per cent in April.
The recent revival of the southwest monsoon and rejuvenation of sowing activity has raised hopes of another bountiful year for agricultural activity, raising expectations that rural demand will soon catch up with urban spending and consolidate the recovery, it said.
Amidst these developments, India’s financial sector remains sound and stable, the RBI said.
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Knock-on effects of geopolitical spillovers are visible in several sectors, tapering the pace of recovery. However, there are sparks in the wind that ignite the innate strength of the economy and set it on course to becoming the fastest growing economy in the world, the fears of inflation notwithstanding, it said.
In another report on ‘Fed taper and Indian financial markets’, the RBI said the mild response of Indian financial markets to the “Taper 2” announcement can be linked to the country’s strong external sector position during the announcement period. “However, there is evidence of large volatility spillovers from the US to Indian equity and bond markets,” the RBI said.
This emphasizes the need for readiness among EME's in terms of adequate buffers, preemptive and calibrated state contingent and data dependent policy responses to withstand future volatility spillovers, it said.
Food inflation is a major component of headline inflation, and has a tendency to spill over to core components. Food inflation was at an elevated level in 2013 as compared to 2021.
The report said the Taper 2 announcement was somewhat anticipated by the financial markets, given the experience with Taper 1, and the Fed’s communication that hinted at chances of taper before the announcement.
Another potential explanation for the resilience in the Indian markets post Taper 2 could be the backing of stronger economic fundamentals in India as opposed to the period before the Taper 1 announcement, the RBI said.
A lower current account deficit as a percentage of GDP, larger foreign exchange reserves, and stronger economic growth in Taper 2 vis-à-vis the Taper 1 period, imply that the Indian economy is in better shape to withstand the Fed’s tightening, and manage any associated change in volatility in the financial markets, it said.
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