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A shipload of speculation has informed the debate over why the Reserve Bank of India (RBI) chose to pull the interest rate trigger on 4 May 2022, instead of anytime earlier or even later. While the timing has certainly fired up the curiosity quotient, here is a vital clue: it is perhaps no coincidence that RBI’s rate hike was announced hours before a US Federal Reserve meeting to also consider a rate hike. This could be RBI’s hat-tip to globalization, despite all the eulogies dedicated to it.

There could certainly be other reasons which are best known to the Monetary Policy Committee (MPC), and, in the absence of clear communication, coincidences will have to suffice. Economic conditions have remained largely unchanged over the past month and yet RBI jumped the gun. Nothing has materially changed since the MPC met in April and decided to hold interest rates: anxieties over an upwardly mobile inflation rate fuelled by geo-political flashpoints and supply chain disruptions, or a visible output gap despite signs of incipient growth impulses, have not altered. Could the March inflation print at 7% (released a week after MPC’s deliberations) and a worsening April situation have changed perceptions? It is unlikely because the MPC minutes seem to indicate inflation woes as a running theme.

So, what changed? Among other things, it would seem that factors influencing the Indian economy’s links with the global economy may have prompted the rate decision. In short, globalization still matters in RBI’s corridors, especially when manifested through exchange rates. India’s close linkages with, and dependence on, the global economy—especially crude oil imports—will continue to influence both monetary and fiscal policy.

The Russia-Ukraine conflict, and its inescapable fallout on globalization, has invited dire predictions from across the spectrum. Blackrock chairman Larry Fink claimed in his annual letter to shareholders, “…the Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades." Howard Marks, chairman of Oak Tree Capital Management, sees the globalization pendulum swinging to the other side, driven by nations’ desire to improve the competitiveness of onshore producers (think Atmanirbhar) and their workforce and “create investment opportunities in the transition".

Epitaphs are also emanating from academia. Adam Posen, president of Washington-based think tank Peterson Institute for International Economics and a former central banker, wrote in a March article for Foreign Affairs: “Over the last 20 years, two trends have already been corroding globalization in the face of its supposedly relentless onward march. First, populists and nationalists have erected barriers to free trade, investment, immigration, and the spread of ideas—especially in the United States. Second, Beijing’s challenge to the rules-based international economic system and to longstanding security arrangements in Asia has encouraged the West to erect barriers to Chinese economic integration. The Russian invasion and resulting sanctions will now make this corrosion even worse."

This promises to have a profound impact on inflation. A 2021 paper by the European Central Bank found that coordinated action by leading advanced economies did have some sobering effect on inflation. The paper said: “Increasing trade integration and greater participation of low-cost producers in global production has a direct disinflationary effect." Conversely, any retreat from this steady state is bound to nudge prices upwards.

However, globalization—an economic system with extensive networks and dependencies—is unlikely to disappear overnight. An Harvard Business Review article finds that despite shocks to globalization, the cross-border flows of goods and services, capital, people and information are still likely to continue, albeit with changes. A caveat might also be in order here: the war in Ukraine is likely to embed trade with inflationary tendencies and force jittery portfolio investors to get parsimonious with funds. The US Fed’s commitment to sledgehammer interest rate hikes—50 basis points on 4 May with promises of more to come—is adding to their nervousness.

This is where RBI’s timing matters. First, with the Ukraine crisis stretching out longer than expected, higher food and fuel prices now seem deeply entrenched. Second, if the market predicts that the Fed will continue to persist with 50-basis point rate hikes over the next few months, along with an aggressive retrenchment of its balance sheet, portfolio investors might swap emerging market assets with dollar assets. This is bound to imbue short-term exchange rates with some volatility, which could then feed through higher imported prices into domestic inflation, further complicating India’s current economic challenges. As economic activity resumes, imports of petro-products have been rising both in value and volume terms. The Indonesian ban on export of crude edible oil to India is sure to add to price pressures.

It can be argued that Fed’s normalization cycle was also public knowledge. It would then seem that RBI’s timing was somewhat dictated by our rapidly widening trade and current account deficits amid sharply elevated commodity prices and portfolio capital outflows, which is showing up in the Indian rupee’s trend line. It might be safe to expect that RBI will continue using a combination of the exchange rate, interest rate and liquidity-based tools to keep imported inflation at bay.

Rajrishi Singhal is a policy consultant, journalist and author. His Twitter handle is @rajrishisinghal.

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