Last couple of years have been characterized by an unusual confluence of black swan events. Initially the Covid complications and now the Russia-Ukraine war disruptions have both impacted each country differently. While economic cycles in major countries were more or less in sync with each other pre-Covid, the same is no longer true. Consequently, each major economy is at a different stage of economic recovery and faces its own unique challenge. The US Fed is way behind the curve on containing decade high consumer inflation and is about to begin a sharp rate hiking cycle. China, on the other hand, is easing monetary policy, while continuing to deal with Covid disruptions amidst a fragile domestic economy. Barring a few commodity producing countries, the rest of the world too is battling very high energy prices in an otherwise slowing economy, thereby complicating the monetary policy decisions.

Given this backdrop, policy makers are in an unenviable position. In this fast changing world, not only are they out of sync with their own economic realities but also with each other. In order to achieve lasting growth footing after Covid, they have been a little flexible with their inflation aim. In absence of robust growth, inflation was largely dubbed “transitory”, albeit not without a lot of debate. But a series of unfortunate events including, but not limited to, unprecedented money printing, production and shipping disruptions, under-investments in energy and commodities, de-globalization and geopolitics around Russia-Ukraine situation have resulted in a stubbornly high global inflation. However, since growth inflation dynamics are different for everyone this time, each country may have to tailor its unique response to their respective inflation situation. 

Compared to the rest of the world, Inflation problem in India has been relatively contained so far. Since the last MPC, domestic Inflation has hardened and breached the RBI’s upper limit of 6% but not by much. In spite of recent fuel price hikes, an upward revision to RBI’s FY23 Inflation estimate of 4.5% is still likely to cap it below 6%. At the same time, long periods of higher than normal inflation come at their own cost. Domestic businesses have already begun to pass on input price hikes to consumers across various products and services. If West is any example to go by, high retail inflation, even if characterized as transitory, can become a political issue due to its disproportionate impact on the bottom of the pyramid. 

So far, the RBI has resisted the temptation of any significant monetary tightening in order to nurture growth. But they may soon have to decide on durability of either Inflation or growth. Whatever be the character of inflation, it may not be allowed to overstay its welcome. RBI has deservingly earned its credibility as an inflation fighter and it should reinforce it with a timely and proportionate response. RBI’s choices are made easier by the fact that a large part of the exceptional pandemic-era monetary accommodation is yet to be unwound. This allows them to gradually withdraw the existing accommodation without running the risk of outright policy tightening pre-maturely.

For now, RBI also has the advantage of time to fine tune the pace of forthcoming policy action as current inflation is within reasonable bounds. In the upcoming policy meeting, the RBI must therefore telegraph its plans on policy corridor normalization and outline a credible path to bring CPI inflation back around 4%. Prospect of a change in policy stance to tilt the policy balance in favor of inflation control is also on the cards sometime soon. Lastly, Bond Markets will look to seek clarity on RBI’s medium term plan around surplus liquidity, targeted level of real interest rates in the economy and the likely extent of RBI support to orderly evolution of the yield curve.