As Fed Chair Jerome Powell noted, supply chain disruptions have lasted much longer than expected, and even now there is little clarity about when the world’s demand for semiconductors and major metals will be met.

Citing high inflation, a strong economy and a tight labor market, the Federal Open Market Committee (FOMC) has chosen to raise the Federal Reserve (Fed) fund rate by 25 basis points to between 0.25% and 0.5 %. In an undeniably aggressive tone, members of the US Fed have indicated that Wednesday’s hike could be followed by at least six more this year. That’s a pretty strong and rapid increase, but not surprising given that US inflation is at its highest level in four decades. It is therefore important to ensure that the economy does not overheat. These are uncertain and difficult times, as central banks around the world grapple with runaway price increases in crude oil and other commodities, geopolitical tensions that could worsen and supply-side disruptions. The price of crude oil may have fallen to double digits, but energy inflation may persist.

As Fed Chair Jerome Powell noted, supply chain disruptions have lasted much longer than expected, and even now there is little clarity about when the world’s demand for semiconductors and major metals will be met. If US stocks rose, it was because Powell did not foresee a wage-price spiral — something the markets feared. At the moment, his concern is more of a supply/demand mismatch and wage increases in some selected sectors. In addition, his belief that the economy is strong enough to withstand rate hikes has reassured markets as it implies that corporate earnings will remain strong. In the absence of details on the pace of balance sheet adjustments – expected in May – liquidity is expected to remain more than adequate in the months ahead.

At home, the situation is slightly different. While it’s true that inflation is on the rise and the CPI has crossed 6%, the top of the RBI’s target band, levels are nowhere near multi-year highs. More importantly, the economic recovery has been uneven and growth could slow sharply after the oil shock. Recent comments from RBI suggest it is more concerned about growth than inflation. Vice Governor Michael Patra compared the 2013 tantrum to the current situation, noting recently that India’s growth story is as weak today as it was then, while inflation dynamics were not as bad. There is some merit in this. First, the record crop and significant buffer stocks, combined with the government’s efforts to manage stocks of pulses and edible oil, could depress food prices. It’s also possible that the lack of a second-round effect on wages and rents, as well as relatively low corporate pricing power, could curb upward pressures on core inflation, as Patra has argued. However, there is much less certainty about fuel inflation unless the government decides to absorb the cost of the increase in the oil price between $80 and $102 a barrel.

Nevertheless, as RBI is pessimistic about the economy – Patra believes GDP would grow only 1.8% from pre-pandemic levels – it is likely to continue its calibrated approach to monetary tightening. It is possible that the central bank will raise the reverse repo rate by 15-20 bps, even if it raises its inflation forecast. But as the growth outlook for FY23 could be subdued, further gains are unlikely. RBI believes these are extraordinary times and the recovery needs support until it becomes more sustainable. Even before the rise in crude oil prices, the economy was not really gaining momentum: GDP grew just 5.4% yoy in the December quarter and private consumption grew just 7% on a weak 0.6% basis . As such, the central bank would not be mistaken if it chose to chase growth.


This post RBI needn’t go the Fed way anytime soon: Supporting the economic recovery still requires a helping hand was original published at “https://www.financialexpress.com/opinion/rbi-neednt-go-the-fed-way-soon-sustaining-the-economic-recovery-still-requires-a-helping-hand/2464352/”

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