US INFLATION AND ITS IMPACT ON INDIA
1. Context
Over the last few days, rising prices have attracted a lot of attention globally and in India. On Wednesday, the United States Labour Department reported that retail inflation had spiked to 6.2 percent in October. On Friday, India's National Statistical Office (NSO) data showed that retail inflation rose to 4.5% percent for the same month.
2. What is the Inflation Rate?
It is the rate at which prices increase over a given period. In India, the inflation rate is calculated on a year-on-year basis. A high inflation rate erodes the purchasing power of people. Since the poor have less money to withstand fast-rising prices, high inflation hurts them the hardest.
In other words, if the inflation rate for a particular month is 10 percent, it means that the prices in that month were 10 percent more than the prices in the same month a year earlier. If the inflation rate was to go up to 15 percent in the same month of the coming year, it implies that something that was priced at Rs 100 in the same month last year, and at Rs 110 this year, will be priced at Rs 126.5 next year.
3. Why is US inflation a matter of concern?
The Federal Reserve, the US central bank, targets an inflation rate of 2%. The 6.2% inflation rate in the US is the largest year-on-year increase in the last three decades. Retail inflation in the US has been rising sharply almost every passing month since May 2020. Hence, the US inflation rate has become a massive concern for its citizens.
4. What has caused the inflation surge in the US?
Typically, inflation spikes can be assigned to either an increase in demand or a decrease in supply. In the US, both factors are at play.
- An increase in demand-The unexpectedly fast recovery spurred an all-around demand from consumers. This recovery was further fuelled by billions of dollars pumped by the government to provide relief to consumers and those who lost their jobs and to stimulate demand.
- The decrease in a supply-The pandemic in 2020 led to widespread lockdowns and disruptions across the world. Companies let go of employees and sharply curtailed production. The supply chains of production spanning several countries and continents were bent out of shape. Since the pace of economic recovery has been much faster than the supply chain recovery, this has worsened the mismatch between demand and supply thus triggering a sustained price rise.
5. Indian perspective on Inflation
- While most other economies were surprised by a spike in prices during the pandemic, India was one of the few major economies where high inflation predated the pandemic. The pandemic exacerbated supply difficulties, even though demand in India has not yet rebounded to pre-covid levels.
- As a result, even though India has entered a "technical" economic recession, the RBI has not cut its benchmark interest rates (repo rate) once since May 2020.
- The RBI has opted to maintain an accommodative stance for as long as necessary to reintroduce and sustain growth and offset the economic impact of Covid-19 while ensuring that inflation remains within target moving forward.
- While overall inflation appears to be quite manageable at the moment, it is "core" inflation that is worrying. The core inflation rate is the rate of inflation when food and energy prices are excluded. It is high and is now on the verge of breaching the RBI's comfort zone. India's inflation could worsen as a result of the global price hike.
6. Effect of US inflation on India
- When prices increase globally, it will lead to higher imported inflation. In other words, everything that India and Indians import will become costlier.
- High inflation in the advanced economies, especially the US, will likely force their central banks to abandon their loose monetary policy.
- A tight money policy in advanced economies would imply higher interest rates. A tight monetary policy involves increasing interest rates to constrain borrowing and stimulate savings.
That will affect the Indian economy in two broad ways. First, Indian forms trying to raise money outside India will find it costlier to do so. Second, the RBI will have to align its monetary policy at home by raising interest rates domestically. That, in turn, may further raise inflation because the production costs would go up.
For Prelims & Mains
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For Prelims: Inflation, Reserve Bank of India (RBI), Repo Rate, National Statistical Office (NSO),
For Mains: 1. Why is the US inflation a matter of concern and explain the effect of US inflation on India?
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Source: The Indian Express
