The world’s oldest democracy (USA) and the largest one (India) have a difficult task each at their hands in pulling off the balancing act between growth and price stability, as incumbent governments in both the nations look up to the polls next year
Whether to let spiraling inflation situation remain freewheeling or to compromise on growth is like picking between the devil and deep sea. Most economies are currently in this dilemma whether to control inflation by tightening monetary policy or ease it off in order to allow growth to happen, at a time when the latter is slowing down and predictions are being made of a likely recession.
Central banks across economies have time and again reiterated their priority of controlling inflation even at the cost of growth. But is it that easy? The answer is no, because the objective is to strike a balance and getting that balance is a hard nut to crack.
Most central banks have been increasing interest rates to make the cost of credit expensive and cool off rising prices. This has led to some moderation in prices of goods and services but mostly below expectations.
Take for instance the situation in the USA. The Federal Reserve has hiked interest rates by a whopping 425 bps in a span of 12 months with four consecutive hikes of 75 bps. This is unprecedented. To its disappointment, the Fed has not achieved what it set out to probably a year back. The central bank chair, Jerome Powell, in one of his monetary policy press conferences admitted this. He, however, clarified that the emphasis still remained on price stability.
The US inflation reached to levels not seen in four decades and the Fed is aiming to bring it down to 2 per cent while keeping employment situation in control. In January, the retail inflation was reported at 6.5 per cent which was more than three times the targeted inflation. Several economists are now questioning the rationale of 2 per cent target which seems unachievable now. A Bloomberg report has said, quoting Allianz Chief Economic Adviser, Mohamed A. El-Erian, that the goal could not be achieved without unsettling the economy.
To the Federal Reserve’s disbelief, US jobs market remains strong and the January non-farm payroll data was much stronger that what was being anticipated. Fed believes that a moderate jobs market will ensure lower consumption leading to benign inflation.
Picture Remains Hazy
After reporting a fall for two consecutive months ending December, the January CPI rose 0.5 per cent shattering hopes of a declining trend. Fed hiked interest rates by 25 bps while remaining non-committal on rate pause or pivot. Powell in January Monetary Policy reiterated Fed’s priority of bringing price stability calling it the biggest challenge of country’s economy.
It is very hard to predict the direction of inflation with geo-political issues like Russia-Ukraine war and US-China face-offs, with the US elections scheduled in 2024 and several unknowns that may potentially unsettle the plans of top economies to tame inflation. Under these circumstances, a 2 per cent inflation target looks like a pipe dream.
Trickle Down Impact
US and China, which are the two largest world economies, are showing signs of a slowdown. The impact will likely be felt across the globe. We are witnessing a stagflation situation where inflation refuses to calm down even as growth takes a backseat.
While the central banks across the world have to fulfill their mandate of controlling inflation, mass lay-offs by companies, is not a rosy picture and very hard on all those who lose jobs at a time when inflation is pinching average households, globally.
The India Story
India remains a bright spot despite being misread in various quarters. The world’s 5th largest economy is expected to grow at 6.4 per cent during FY24 as per the estimates of the Reserve Bank of India. India’s central bank has downgraded the GDP growth marginally from an earlier estimate of 6.8 per cent.
India has also reported a higher CPI number in January 2023 at 6.52 per cent, up from 5.72 per cent. The RBI’s comfort levels on inflation are at 4+/-2 per cent. The banking regulator, earlier this month, increased the policy rate by 25 basis points bringing the repo rate at 6.50 per cent.
Even as rates are on an uptrend for over a year now, it might now be nagging the common man, especially the Indian middle class who relies heavily on bank loans for virtually everything, be it home buying, vehicle purchase, education and wedding. A higher interest rate on the long term is a dent on its pockets.
Despite all this, the Indian consumption story has been robust with record month-on-month collections in Goods & Services Tax; automobile manufactures reporting record sales and travel and tourism picking up.
But, we are not without challenges. If the world slows down, the India story could be hit somehow as exports will take a blow. We are witnessing contraction in exports growth. In January, exports dipped over 6 per cent to USD 32.91 billion – a second consecutive decline. In FY2021-22, exports touched a massive USD 422 billion.
India has not remained untouched from the massive lay-off by top US organisations, primarily tech companies. Google is the recent among major tech company to join the bandwagon. It has announced its decision to discharge 450 people from its Indian operations.
When interest rate go up, companies are also hit as they may have to shell out more money as interest payments; cost of key inputs and resources go up as a result of this, shooting up their operational costs.
India has weathered two consecutive global shocks in the form of Covid-19 pandemic and the Russia-Ukraine war, thanks to policies of the government and the RBI. The government has also spent heavily to provide a much-needed impetus to growth even as the participation from the private sector has remained lackluster.
There is a challenge at hand for both of the world’s prominent democracies in manoeuvering a balancing act between growth and price stability. How the acts on inflation and growth are performed at both ends of the world could also be a big factor in the 2024 mandates.