Globalized inflation may necessitate more than the RBI's measured response

9 Jun 2022 , 10:10 AM

The “globalization of inflation” resulting from the Russia-Ukraine war, which has generated a broad-based rise in global commodity prices, has been blamed for the higher-than-expected rise in inflation in recent months. As a result, the RBI’s main worry is geopolitical shocks resulting in unbalanced inflation expectations and their second-order effects.
 
The monetary policy conduct is now more explicit on the elimination of monetary accommodation with the goal of moving to a normalized policy, which could assist offset the negative geopolitical consequences for the Indian economy.
 
This normalization, according to the RBI, is a measured process that includes a reduction in surplus liquidity over a multi-year period in the hopes that its anti-inflationary actions would not hinder GDP.
 
The RBI looks optimistic about growth, implying that it is strong enough to survive policy normalization. As a result, real GDP forecasts for FY23E remain constant at 7.2 % on average. It is envisaged that private investments would finally pick up, based on an increase in capacity utilization to 74.5 % in 4QFY22, a pick-up in credit demand, and capital goods imports.
 
The impact of globalization of inflation on advanced nations’ monetary policy, notably in the United States, is perceived as worsening financial circumstances for developing economies. With some expansion of the current account deficit and regular FDI, ECB, and other flows, the RBI considers that external balances will still be sustainable.
 
Surplus liquidity, as measured by the RBI’s LAF balance, has dropped drastically from 5.4 % of bank deposits in October 2021 to 1.9 % by the end-May of 2022. By the end of FY23, it is quite likely that it will have converged to the typical level of 0.5 % of bank deposits. Going ahead, this should result in a bearish flattening of the G-SEC curve.