inflation

Will Global Uncertainties Increase Inflation and Interest Rate in India?

”Gas is finished,” shouted Ruma from the kitchen.

”I am booking the next cylinder online,” replied Sudeep.

It was a Monday morning, and he thought he should book the next cylinder or he might forget once he is in the office.

Sudeep opened the online booking page of the gas supplier’s portal and clicked to book a cylinder.

While making the payment online, he noticed that the price is now higher by Rs 50 than last month.

”Cooking gas price is hiked again, should we curtail our cooking and eat more salads hereon?” Sudeep wondered aloud.

”Not so easy, vegetable and fish prices are also up,” informed Ruma, ”And the boy who delivers puja flowers at home had also said that the flower prices increased; he would have to charge more.”

Disgusted, Sudeep threw away the morning newspaper which bore the news of continuous petrol and diesel price increase.

As if Covid was not enough, now the Russia-Ukraine war is adding further insult to the injury. Price rise is hurting, and it is a huge global phenomenon.

Inflation is Setting in Globally

Inflation is rising globally and almost all countries are facing its effect. The US, which had little inflation for years, is now experiencing inflation the country never experienced in the last 40 years. The annual inflation rate is now 7.9% by February 2022, a high unheard of since 1982.

If the growth of inflation numbers is scorching in the US, Europe is no better. The annual inflation rate in Germany was confirmed at 5.1% in February of 2022, matching the preliminary estimate, and accelerating from a 4.9% rise in the previous month, due to faster rises in prices of goods (7.9 percent vs 7.2 percent), mainly boosted by energy (22.5 percent vs 20.5 percent) and food (5.3 percent vs 5 percent).

A similar picture in the UK too. The annual inflation rate in the UK increased to 6.2% in February of 2022 from 5.5% in January and above market forecasts of 5.9%. It is the highest inflation rate since March of 1992.

Why are the major economies witnessing such massive spikes in inflation numbers? Will it affect India too? Will the interest rate rise now in India? Is it only the effect of war? Or is the problem far deeper?

We will discuss the issues one by one.

Inflation is Rising in India Too

Inflation is raising its ugly head in India too and the recent fuel price hike is likely to accelerate it further.

The annual inflation rate in India accelerated for a 5th straight month to 6.07% in February of 2022, the highest since June of 2021, and above market forecasts of 5.93%. It is just above the RBI’s comfort level of 2-6%.

Reasons for Inflation Spike

Inflation happens when too much money chases too few goods. That means the availability of goods is not adequate compared to the purchasing power of the consumers. Although this is the basic reason for inflation, this time the reasons are a little more complex. Let’s dig a little deeper.

After the reopening of the economy after the Covid pandemic, consumers started to go back to the old way of spending. But there were not enough products to buy. Shortages of key materials like lumber and semiconductors hampered activity, and sellers raised prices to make the most of the imbalance. Metals and other key industrial raw materials prices have also gone through the roof because poor output during the pandemic turned into sudden high demand.

Bottlenecks in supply chains were also “larger than expected” and contributed to stronger inflation.

Lingering uncertainties among investors and business owners around the pandemic’s future have also lifted prices.

Wage hikes to help workers beat inflation are further increasing the money supply in the economy and are raising inflation in its turn.

Inflation Expectations

As inflation becomes sticky across the economy, consumers and businesses develop an expectation of high future inflation. This initiates a chain of events that further increases inflation.

In the face of sticky inflation, wages are raised. Businesses, in turn, raise prices to cover the cost and the resulting effect further stokes inflation.

At the same time, consumers increase spending and investing and this also helps inflation to go up.

There is a danger of falling into a vicious cycle unless supply-side problems are not addressed forcefully.

Fighting Inflation

Generally, central banks across the world devise and implement policies to contain inflation. In India, RBI regularly comes out with policy measures to contain inflation.

In a country like India, uncontrolled inflation can damagingly devalue the currency with detrimental effects as we need to import a large number of goods, especially crude oil. And crude oil prices have shot up because of the Russia-Ukraine war and supply disruptions. In fact, most goods that we import such as edible oil, metals, industrial goods, chemicals are already costlier in the international market.

The major weapon the central bank has in its arsenal is to increase the interest rate. The US central bank, Federal Reserve, has already started walking on that path with clear policy statements.

Although RBI is still expecting that inflation will remain moderate in India but the continuing Russia-Ukraine war is massively disrupting supply chains besides elevating crude oil prices.

Historically, high crude prices have always increased inflation in India, and an interest rate hike is the first line of defence to fight it.

One thing is for sure, there is no real chance of further decrease in interest rate in India, and we are seeing the lowest home loan rate in a decade.

The economy is cyclical. The low-interest regime is not permanent. It will be surely followed by a high-interest period.

It looks like such a period is round the corner.

The interest rate is sure to go up from hereon.

The only question is when.

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