The Fed-RBI Decision Dissonance

We’ve established that inflation is a problem, and have been speaking about it in copious amounts since several weeks now. However, there are stark differences in how it is being tackled in the US and in India.

The Fed increased rates in the US, and indicated that it would do through the rest of the year. At the same time, last week, Fed Governor Lael Brainard and San Francisco Fed President Mary Daly said the central bank was committed to fighting inflation.

Hawkish comments indicated higher rates and more aggressive winding down of the balance sheet. Basically higher rates, and cooler economy. These comments had a negative impact on stocks.

However, what happened last week in India was different. RBI kept rates unchanged, despite inflation being higher and despite central banks globally increasing rates. This has been in line with RBI’s pro-growth stance, and its view that high inflation is transitory in nature.

Why is there a stark difference?

1. The US has been fuelled by a super-easy monetary policy for years now. India on the other hand has not been so monetary-stimulus driven. India’s growth has been more structural, fiscal-driven and inbound. Its reliance on central bank policy has been relatively lower.

2. The US has been seeing a very tight employment market. At 3.5% unemployment rates have been at their lows. A tight labour market determines shortage of talent, and a natural upward pressure on wage inflation, which also results in a consequent impact on overall inflation, unlike in India.

3. While the US has been imposing sanctions on Russia, which initially drove oil prices higher, it later also announced its largest-ever release of its crude reserves. Fact remains that 1 million barrels per day only account for 5% of its daily consumption, and that relief may be short-lived. However, India on the other hand, despite its frenzy of price hikes has started sourcing Russian crude at discounted prices.

4. As India moves closer to the General Elections in 2024, government spending is likely to increase, a fiscal stimulus is bound to push growth higher. Here, the central bank too is pro-growth, and monetary and fiscal policy are both aligned.

What happens next?

1. Inflation in India is a real problem, with rates increasing across the board. This is bound to hurt demand to some extent, and corporate profits too. This may result in near-term headwinds on the Indian markets. But over the long-run, India seems well-poised to continue seeing bullish trends.

2. Historically, rate increases in the US means money moves from emerging markets like India to the US, for a better risk-reward. However, over the years, India’s dependence on foreign funds has come off. Domestic inflows form a larger proportion of the markets, and supply-driven pressures seem less of a worry for India.