Inevitable stagflation?

The fear of the pandemic has still not faded, and the development outlook remains uncertain globally due to the geopolitical crises. The spread of Omicron in China and Russia's attack on Ukraine has worsened the global situation. In the international market, the benchmark crude Brent has remained consistently above USD 120 a barrel, which is likely to remain higher in the coming months as well.

In the current scenario, the global economy is heading towards recession. Almost all the major economies of the world are vulnerable to rising inflation and Central banks of advanced countries are compelled to increase policy rates to control inflation. Share markets across the world, including in India, witnessed heavy selling on June 13 due to rising inflation and fear of a sharp rate hike by Central banks and a possible negative impact on economic growth. Investors are feeling that the increase in rates by the Central banks may affect the economic growth of the world.

Due to the economic slowdown, the purchasing power of the people decreases. Today, the purchasing power of people of many countries in the world, including India, has reduced. In such a situation, incomes of people do not decrease, but due to the decrease in the value of currency, people are neither able to buy the necessary goods nor able to save money for the future. Economic activities begin to slow down. A decline is seen in both production and growth rate. Job creation stops and existing jobs start slipping out of the hands of the people. Due to inflation, there is a decrease in the demand for various products. Consequently, factories are compelled to reduce production, and if such a condition continues for a long time, the companies are closed also.

To control inflation, the Reserve Bank of India has increased the repo rate by 0.50 per cent in the recent monetary policy review. Earlier in the first week of May, the repo rate was increased by 0.40 per cent by the Central bank. With the latest hike in the repo rate, it has now risen to 4.90 per cent. After the increase in repo rate, all Indian banks are increasing the lending rates. State Bank of India has hiked the lending rate by 20 basis points on June 15.

Increase or decrease in the repo rate has a direct effect on inflation and the loan rate. An increase in the repo rate leads to an increase in the loan rate, at the same time, the possibility of a decrease in inflation increases because due to high loan rates, banks give loans at an expensive rate, reducing money in people's pockets. Owing to low income and high price of products, demand falls and, when the demand for a product falls, its price also falls.

The repo rate was cut by 0.75 basis points in March 2020 and by 0.40 basis points in May 2020. Due to the pandemic, the Reserve Bank made this cut in the repo rate to establish a balance between demand and supply and to maintain the growth rate. The repo rate before the pandemic was 5.15 per cent. Since inflation is not likely to ease quickly, the Central bank may gradually raise the repo rate above the pre-Covid level to keep it under control.

The Reserve Bank of India stated in its latest monetary policy review that the inflation rate may remain above six per cent in the coming quarters. The Central bank has increased the inflation forecast for the FY 2023 from 5.7 per cent to 6.7 per cent. According to the Governor of the Reserve Bank of India, inflation can be 7.4 per cent in the second quarter of the financial year, 6.2 per cent in the third quarter and 5.8 per cent in the last quarter.

The Reserve Bank of India has kept the inflation tolerance range between 5 and 6 per cent. In the US, this limit is 2 per cent, but their inflation reached a level of 8.6 per cent in May, the highest since December 1981. In the US, the yield on the 10-year American bond has risen to 3.2 per cent. To control inflation, the US Federal Reserve has increased the interest rate by 75 basis points on June 15. Inflation in Britain and the Eurozone has broken the 40-year record and has reached a level above 8 per cent.

In May, the Central government had cut excise duty on petrol and diesel to control inflation. The government believed that due to some reduction in the expenditure on transportation, there would be a little bit reduction in the price of essential products and there would be some relief to the common man, because now, a large part of the income of the people is incurring on their daily needs.

Saudi Arabia (12 per cent), Russia (12 per cent) and America (18 per cent) are the three largest oil-producing countries in the world. India imports 85 per cent of its oil — mostly from Saudi Arabia and America but also some from countries like Iraq, Iran, Oman, Kuwait, Russia etc. Russia produces 10 per cent of the global demand for natural gas, and sells 40 percent of its oil and natural gas to Europe. With one dollar increase in the price of domestic natural gas, the price of CNG in India increases by about Rs 5 per kg. Ukraine is also the world's largest exporter of refined sunflower oil. In second place is Russia. India imports sunflower oil from these two countries and buys fertilisers in large quantities from Ukraine. Ukraine is India's largest supplier of nuclear reactors and boilers. Russia is the world's largest exporter of palladium, which is used in the manufacture of many valuable products.

At present, both domestic and international factors are responsible for high inflation, but international factors are more important. The solution to the geopolitical crisis is yet to come. Russia and Ukraine still stick to their respective egos. In the current scenario, it can be said that due to the ongoing war between Russia and Ukraine, inflation is increasing in many countries of the world and the global economy is moving in the direction of recession. However, even in the current environment, the Indian economy has become stronger than the pandemic period. Retail inflation in the country softened to 7.04 per cent in May from an 8-year high of 7.79 per cent in April, but the picture in the US and European markets is still unclear.

Views expressed are personal