Another major issue affecting advanced and developing economies alike is global supply chains, which continue to be severely affected by the events of the past two years. Transport costs have skyrocketed. And unlike the oil-based supply shock of the 1970s, the COVID-19 supply shocks are more diverse and opaque, and therefore more uncertain, as the World Bank’s most recent report suggests.
In EMDEs, currency depreciation (owing to lower inflows of foreign capital and downgrades of sovereign credit ratings) has contributed to inflation among imported goods. And because inflation expectations in EMDEs are less anchored and more attuned to currency movements than in AEs, the pass-through from exchange rates to prices tends to be faster and more pronounced. But again on this count, the Modi government has done a stellar job. Brokerage firm ICICI Direct said that unlike in 2013 when the Rupee depreciated drastically after the U.S. Fed announced monetary tightening, India currently holds the fourth largest forex reserves globally, at almost $600 billion, and also has had a surplus BOP, all through 2020 and much of 2021.
In the light of abundant foreign exchange reserves and the strong performance of the Rupee vis-a-vis its global peers, Rupee’s depreciation beyond Rs 80 per US Dollar in the calendar year 2022 is highly unlikely. Do note that most economists believe that even at 80, the INR is overvalued and hence there is little cause for worry, at this stage. Rupee, in May 2022 has been trading in a range of Rs 77.45 and 77.72 to the Dollar. The Rupee is likely to face resistance near 80 levels and strengthen back to 74-75 levels in the coming months, as India seems to be in a better position to withstand any major shock from the global monetary tightening that is currently underway. Don’t forget that only as recently as on 12th January 2022, the INR was at 73.77 to the Dollar. India’s forex reserves are equal to about 12-14 months of import cover. Given that the Rupee has enough cushion to withstand external shocks and is unlikely to breach the 80 to a Dollar level anytime soon, imported inflation on account of a depreciating Rupee has been kept in check and here again, the Modi government deserves kudos for the excellent handling of India’s external economy. The current INR depreciation is not India specific but part of a larger global trend, with most major currencies falling against the Dollar in May 2022 after the Dollar index reached 103.94, the highest since December 2002, on May 6, 2022, after the Fed’s 50 bps rate hike and hawkish commentary. US 10-year yield also hit its highest at 3.14%, since 2018, on May 4, 2022, though it has softened a tad bit since then, at just shy of 3%. Sterling fell to its lowest level in May 2022, since June 2020, after the Bank of England raised interest rates to their highest since 2009 and warned that the economy was at risk of recession. The Euro was also dented after German data showed that industrial orders in March 2022 suffered their biggest monthly drop since last October. The single currency has fallen as the region struggles with weaker growth and energy disruptions due to sanctions imposed on Russia after it invaded Ukraine.
India’s current account balance recorded a deficit of $9.6 billion in the July-September 2021 quarter, as against a surplus of $6.6 billion in the April-June 2021 quarter, but the deficit was mainly due to the widening of trade deficit, with economic recovery kicking in. A major achievement of the Modi government undoubtedly has been reining in the current account deficit (CAD). It is a well-known fact that a higher CAD leads to imported inflation, something the Modi govt has assiduously avoided. In FY18, FY19, and FY20, India’s CAD was 1.8%, 2.1%, and 0.9% of GDP respectively. In FY21 India reported a current account surplus (CAS) of 0.9% of GDP for the first time in over 17 years. For a fast-paced economy like India, a CAD of 2.5-3% of GDP is not a problem, ideally speaking. However, one needs to be reminded that in FY13, under an incompetent Congress, India’s CAD had snowballed into a dangerously precarious level of 6.8% of GDP, completely destroying India’s external economy and setting the stage for high inflation. Hence Congress has no business lecturing the Modi government on the handling of inflation or related matters.
The balance of payment (BOP) has remained in surplus on strong FDI inflows (FDI inflows into India stood at a robust $83.57 in FY22) and a narrower current account balance in the last few quarters. In FY23, even if the trade deficit widens as the economy reopens, strong inflows will keep the current account deficit in check. A fact worth mentioning here is that in 2021, the Rupee depreciated only 1.8% against the Dollar, outperforming its global peers such as Japan’s Yen, South Korean Won, South African Rand, and EU’s Euro which depreciated by a far higher level of 11.5%, 9.7%, 8.5%, and 7.9% respectively. More the depreciation, more the chances of importing inflation. It is because the Modi government has managed the current account balance very effectively, that the Rupee has not seen any untoward volatility, which in turn has helped India in reining in imported inflation, despite India being a net oil importer and a net Commodities’ importer.
A rise in risk appetite in the global markets helped the Rupee perform better than its peers in 2021. Inflation which largely remained under RBI’s comfort zone in the last year, helped the Central bank to maintain lower borrowing costs to support the economic recovery and this also contributed to Rupee’s steady performance. Food accounts for a much larger share of the average household consumption basket in EMDEs, which means that inflation in those economies is likely to prove persistent. Today’s higher energy prices will translate directly into higher food prices tomorrow (through higher costs for fertilizer, transport, and so forth). Food inflation is the most regressive form of taxation as it burdens the poorest, the most. And it is here that the Modi government, reached out to the last mile standing, via the PM Garib Kalyan scheme.
In the absence of global policy options to resolve supply-chain disruptions, the task of addressing inflation is largely left to the major Central banks. While the US is poised to undergo a modest tightening (by historical standards) in 2022, this is unlikely to be sufficient to rein in inflation. The US Federal Reserve’s tendency to do too little, too late is well known. The US and other advanced economies failed to tackle inflation quickly during the 1970s and they ultimately needed far more draconian policies, which led to America’s second-deepest post-war recession, along with a debt crisis. As the old saying goes, “A stitch in time saves nine.” So while the US and large parts of the developed world are likely to grapple with hyperinflation or stagflation, which could further deteriorate into a recession going forward, the timely moves by the Modi government to give over Rs 2 lakh crore worth of cash to farmers via PM-Kisan or say free food and free ration to the needy, collateral-free loans to MSMEs via the ECLGS scheme and liquidity support to the contact-sensitive sectors, have all worked wonders. The US Fed raised its benchmark rates by 25 basis points in March 2022 followed by a lumpy 50 basis point rise in May 2022, bringing the threshold benchmark rate from zero in February 2022, to a stiff 0.75% in May 2022. But this 75 basis point interest rate hike, may still not be enough to curtail galloping US inflation, what with the Fed running a massively bloated balance sheet that needs drastic surgery. There are of course talks of the US benchmark interest rate rising to 1.9% by July this year and 2.7% by the end of 2022 or early 2023. A rise in US interest rates, other things remaining the same, is usually associated with global risk aversion which in turn could keep the Rupee and all other currencies relatively weak. However, as mentioned above, the INR is unlikely to fall beyond 80 to the Dollar, due to supporting factors.
External geopolitical factors such as the Russia-Ukraine war and the resultant supply chain disruptions have led to an increase in the prices of several essential items such as energy, food, and metals. Many argue that since India imports a fraction of its oil from Russia, the ongoing crisis there should not have an impact on Indian fuel prices. These people miss the fact that the effect is felt on the Indian basket of crude oil, which has a direct impact on the price at which India buys Oil. The price of Oil available for import by India increased from about $73.3 a barrel in December 2021 to over $110 a barrel in the first week of April 2022. In March 2022, the Indian energy basket recorded its highest price at $128.24 per barrel, while Brent Crude went ballistic, beyond $130 per barrel for the first time since 2008, the highest in 14 years. Even in mid-May of 2022, Brent Crude has been trading at between $110-$113 a barrel.
India imports over 83% of its Oil requirement. In addition, since fuel prices are relatively unregulated in India, this means external events can have a significant impact on domestic fuel prices. However, despite this, prices of Petrol and Diesel were not changed since December 2, 2021, for 137 days in a row. LPG prices were not changed since October 6, 2021, or 167 days. The current hikes in Petrol and Diesel prices come against this background. The hikes in Petrol and Diesel in India by 5-10% in early 2022 are minuscule compared to the massive rise of anywhere between 52-58% in other countries, in the last few months. In the US, Petrol costs an average of between $4.5 to $4.637 per gallon, which is nearly 20% higher than the price just a few months ago. In the UK, Petrol prices have consistently been hitting all-time highs over the last month, with the latest price being between 1.6 to 1.79 pounds a litre. This is over 20% higher than it was a few months ago. In Germany, the price of Petrol has increased by 15% over the last few months alone.
Retail food inflation (CFPI), which affects the common man the most has remained benign in India through most of the year and slightly increased recently to 5.85% in February 2022 and 6.95% in March 2022, due to external factors. Average inflation for the period April-March 2021-22 stood at 5.85% as against 6.22% in the corresponding period the previous year, as in, the pandemic year. In the monetary policy announced on 8th April 2022, the RBI raised its inflation projection for FY23 from 4.5% to 5.7%, primarily on account of the phenomenal rise in global Crude Oil prices. But 5.7% is still lower than RBI’s upper band of 6%.
RBI maintained an “Accommodative stance” but hiked the Repo rate in May 2022, from 4% to 4.4%, for the first time since August 2018. Of course, with the 10-year benchmark yield hitting 7.4% recently and hovering largely around the 7.35-7.38% levels, at some point this year RBI will have to move to a “Neutral stance” and raise the Repo rate more frequently and sharply, to curtail inflationary expectations. But since calibration has been the essence of RBI’s policy, rather than lumpy hikes, any rate hike will also likely be a calibrated one, which is absolutely the right way to do it. Post the Repo rate hike, the standing deposit facility (SDF) rate stands adjusted to 4.15% and the marginal standing facility (MSF) rate, and the Bank Rate to 4.65%.RBI also hiked the cash reserve ratio (CRR) from 4% to 4.5%, to suck out excess liquidity of Rs 87000 crore from the system. To cut to the chase, the RBI has been very nimble-footed.
Since the Modi Government took charge in 2014, inflation has remained under control. Retail inflation crossed the 6% mark only eight times between May 2014 and March 2020, when the nationwide lockdown was announced to protect the nation from COVID-19. Post-pandemic, the rate of CPI inflation crossed the 6% mark only rarely, and that too only in response to external, largely uncontrollable factors. To set some context, it is important to note that the country experienced the worst era of inflation from 2010 to 2014 under the Congress-led UPA. (To be continued…)
The writer is an Economist, National Spokesperson of the BJP, and the Bestselling Author of ‘The Modi Gambit’. Views expressed are the writer’s personal. Part one of the article was published last week.