In early September, India’s GDP growth rate in the first quarter of 2022-23 at 13.5% was below RBI’s target of 16.2%. Slower-than-expected growth usually requires lower interest rates. Ironically, at the end of September, RBI had to increase the repo rate by another 0.5%. Most people expected this increase since the United States had recently hiked the interest rate, triggering an exodus of investors from India to the United States. The US economy acting like a black hole is sucking up global liquidity through massive and successive interest rate hikes. The euro, the yuan, the yen, the pound or the rupee all seem to have weakened. Economies are drained of the strength to retain their capital. Generating interest seems to be the only defense against this onslaught. It’s like a monetary union where countries lose their autonomy over monetary policy. But, a monetary union attempts to balance the interests of all member countries. Does the USA do it? No. In fact, more hikes are in sight!
Unilateral decisions of the United States
On March 21, 2022, ahead of the Business Roundtable’s quarterly CEO meeting held in Washington, President Biden remarked that “there is going to be a new world order out there, and we have to lead it. And we must unite the rest of the free world to do so.” It came after the Fed raised interest rates by 25 basis points, the first since 2018. Since then, a whopping 2.75% hike has been made in four announcements. These rambles are one-sided and at odds with Biden’s words “…I have to unite the rest of the free world to do this.” Bloomberg columnist Marcus Ashworth writes, “If the Fed raises rates with a vengeance, the effects will be felt outside of its domestic purview: Parts of the global economy will collapse. The article is titled “Jerome Powell to the Rest of the World: Drop Dead”.
Contrasting situation in India
India celebrates Amrit Kaal in stark contrast to ‘drop dead’. Contrasting are his actions in managing the economy. During the onslaught of COVID, the United States relied on triggering demand by printing $120 billion a month and targeting a near-zero interest rate. Several US-based economists have also suggested the same for India. Nobel laureate Abhijit Banerjee has been vocal in prescribing India to print more money and not worry about the budget deficit. His statements, first in April 2020 and then in June 2021, caused people to fear that India was not following the “helicopter money” approach, fueling heated discussions that flooded social media. US and Indian geopolitical interests may correspond to a large extent, but the two have stark differences in the structure and size of the economy. The differences compel India to follow a strategy suited to its economic interests. In a globalized world, wired by massive trade and capital flows, unilateral decisions can create turbulence for other economies. The magnitude of the turbulence increases with the size of the country’s GDP. So when the United States sneezes, the world freezes. India cannot afford the kind of remedies that the United States has. The rapid printing of dollars followed by rapid increases in interest rates cannot be imitated.
Most economies will collapse in doing so. Otherwise, some economies will also collapse, as Ashworth puts it. Can India dodge these salvos? Is there a way out of this massive demand destruction? Is following US interest rate hikes a good strategy? Will this prevent capital outflows? So far, the RBI has raised the repo rate to defend against rate hikes in the US. Rising repo rates appear to be weighing heavily on Indian GDP growth. The GDP growth outlook for 2022-23 has been revised down by international rating agencies, IMF, World Bank, RBI and SBI. Budding green shoots of growth are crushed. India cannot afford to shake investor confidence. The PMI for manufacturing and services appears to be healthy in August. The growth rate of bank credit, at 15.5% in August, also seems encouraging. But, rising repo rate can shake confidence. Slower GDP growth coupled with high imported inflation can be catastrophic for the economy.
Dispelling Inflation Fears
It should be understood that above-target inflation in India is not due to internal reasons. Therefore, it cannot be solved by domestic reasons. The first rate hike by RBI in May 2022 was in anticipation of the rate hike by the Federal Reserve Bank. It was not made to curb inflation. Inflation in India was and is much lower than in the US, EU and other neighboring countries except China. Higher inflation in other countries improves our global competitiveness and our exports. Higher exports keep our factories running and create jobs. This should be kept at the highest priority. The free ration for 80 million people, ongoing for two years, has helped ease the pain inflicted by inflation on the poor. It was to end in September, but is retained. Raising the interest rate in India is like giving a hard slap to the crying child for milk since the milk is not there. Increasing the supply is the solution. Rising interest rates will stifle supply.
Is there a risk of the Rupee falling if the RBI doesn’t match the Fed’s interest rate hike?
Despite this fear harbored by many, this does not seem to be happening. The United States cannot afford the dollar to continue to strengthen. The US current account deficit in the second quarter is around $250 billion, or 4% of its GDP. In the previous quarter, it had reached around $270 billion. The deficit was reduced due to increased crude oil exports from the United States. Courtesy of Ukraine-Russia War. The US current account deficit over the decade 2010 to 2020 ranged between $80 billion and $120 billion. In the last two years, it has increased by 250%. It is unbearable. The US dollar must weaken to strengthen the economy. If the US dollar remains strong while the rupee weakens, this will boost export demand in India. The $750 billion export target for FY 2022-23 is rigid. A weaker rupee will help. Russian oil will also help. The RBI no longer needs to increase the interest rate. Raise the toast to reach export records!
The opinions expressed above are those of the author.
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