The minutes of the December meeting of the US Federal Reserve, released last Wednesday, suggest to a faster-than-expected hike in US interest rates to combat inflation. Stocks plummeted, bond yields climbed, and cryptocurrency prices plummeted as a result of the news. The inflation concern is genuine, especially now that the Fed has stated that it may cut its balance sheet (sucking liquidity). According to the minutes, once the process starts, the acceptable speed of balance sheet runoff will likely be faster than it was during the previous normalisation session in October 2017. As a result, central banks and markets should not be surprised if the dovish approach continues.
The RBI’s claim that its “monetary policy approach is principally attuned to emerging domestic inflation and economic dynamics” is now being put to the test. RBI’s policies may end up chasing, rather than guiding, the market if they continue to be shaped by the demands of the Indian economy rather than global events. The financial markets are linked. As a result, the RBI must act in concert with other central banks rather than acting independently.
A tighter Fed might result in capital outflows from India, as well as concerns about exchange rates and interest rates. The rupee may weaken, but this would address the long-term strength in the actual effective exchange rate and boost Indian export competitiveness. Imports will become more expensive. The RBI must weigh the risk of imported inflation against the rupee’s devaluation. It should collaborate with the Government of India to ensure macroeconomic stability and prepare markets to avoid excessive volatility.
Crude oil prices have dropped. However, rather than surplus demand, input prices continue to drive inflation. Fixing supply bottlenecks and avoiding curfews are required to keep inflation under control. Due of concerns about Omicron’s spread, most states have implemented curfews. Supply networks will be interrupted once more, delaying the revival of the economy. States must concentrate on pandemic control rather than lockdowns. To absorb any shocks, the GoI must also spend more to accelerate up economic activity.