Frontloading of policy action needed to tame inflation expectations: RBI bulletin

Source: Financial Express, 18 July 2022

The Reserve Bank of India (RBI) has stressed the need for frontloading of monetary policy actions to keep inflation expectations firmly anchored and re-align inflation with the target while reducing the impact such actions will have on medium-term growth, the central bank said in its bulletin for July. To that effect, the RBI has already initiated coordinated monetary and fiscal policy responses.

While the role of monetary policy to control inflation caused due to global supply shocks leaves limited space for the RBI to maneuver, there is risk of unhooking of inflation expectations due to the increasing intensity and frequency of such supply shocks, the RBI said, citing the ongoing supply side issues stoked by the Ukraine war and rebound of pandemic.

If crude prices increase by 10%, inflation could increase by around 30 basis points (bps) at its peak and gross domestic product (GDP) will weaken by 20 bps, the RBI observed, which requires monetary policy tightening to push inflation back to target. In such a scenario, the government will have to opt for reduction in its capital expenditure to maintain the trade deficit target or maintain the spending target and go for a higher trade deficit. Although the required interest rate tightening is lower in either scenario, there will be spillover effects on the growth of the economy, the RBI said.

In a separate article of the bulletin, the RBI had said that India can overcome the worst surge of inflation if the commodity prices soften and supply chain issues are resolved.

India’s current account deficit (CAD) was 1.2% of the gross domestic product (GDP) in FY22, slightly lower compared to 1.3% in the previous year. Although the deficit moderated to 1.5% in the fourth quarter of FY22 from 2.6% in Q3FY22, the surging oil prices are likely to have widened the current account deficit to 2.7% of GDP in Q1FY23, ICICI Securities said in a report.

The widening trade deficit leads to the depreciation of the Indian rupee due to depletion in foreign exchange reserves, which has resulted in a massive $8.1 billion decline in the country’s foreign exchange reserves as of July first week, the latest RBI data shows. The rupee is expected to depreciate further and may test psychological levels of 80.00 in coming sessions, the brokerage had said in another report earlier this month.

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