INFLATION and GROWTH – Global and Indian Perspective

Fed in on the inflation offensive and it is time for consolidation

The US Federal Reserve has taken a determined stance against inflation raising its key benchmark rates an aggressive 75 basis points at the latest FOMC meeting in one of the highest rate hikes since 1994. The US Fed’s rate spike comes after a 50-basis point hike in the Fed rate the last time with cumulative rate hikes now showing at 125 basis points increase.

With the US consumer price inflation accelerating to a 40-year high of 8.6% in May rising 100 basis points from a month earlier, the Fed’s policy shift is a little late, but a step in the right direction. Housing, food and surging oil prices are beginning to take a toll on household finances. High oil prices are further fuelling transportation costs continuing the pressure on global inflation.

The US Fed noted that inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, high energy prices and broader price pressures. With the conflict in Ukraine driving oil and gas prices higher, global inflation is likely to remain elevated in the foreseeable future.

More hikes on cards

Fed forecasters see inflation continuing to play truant for the rest of the year with average rates at about 5.2%. But the US Fed is ‘strongly committed’ to clawing back Inflation to about two per cent, and according to its policy inflation should decline to 2.2% in 2024.

More rate hikes are on the horizon with the US Fed seeing another 50 or 75 basis points hike in the next FOMC meeting due in two months. Indeed, aggressive rate hikes could continue with forecasters anticipating the US median rate to be about 3.4% by the end of this year.

While the rate hikes are expected to impact US and global growth rates, however, one of the key positive takeaways is that a deep recession is not on the cards. The US economic growth is expected to decline below 1.7% this year further showing signs of decelerating in 2023. US unemployment is also expected to inch up in the coming quarters.

Growth effects

The Indian economy is expected to feel the heat of the global slowdown due to fiscal tightening. The rupee, which has remained steady for the last many quarters, has come under pressure lately with its pricing breaching the Rs 78 mark to the dollar. High oil prices are India’s biggest concern and if it continues to remain elevated, the slack in the economy could be prolonged.

For now, the global and Indian economies will have to come to terms with this period of stagflation. Global asset prices have weakened this year and may remain under stress for the foreseeable future. Asset prices are now being re-priced after factoring in higher interest costs. High growth companies, whose valuations were even driven higher by the liquidity-fuelled markets, should see a more sobering price-earnings multiple in the foreseeable future.

One of the good things is that India’s gross savings rate is high, and these savings are being funnelled into the broader economy. A thrust on infrastructure investments including roads and railways will lower costs and improve economic efficiency should benefit the growth in the longer run. Some of these savings may be shifting to the fixed income side as interest rates rise which should increase liquidity with banks and financial institutions leading to higher core infrastructure lending.

All in all, for the economy, this period of rate tightening is a time of consolidation and increasing capital allocation and efficiency. India’s investments during this phase will determine how quickly the economy will begin to recover back on the growth path.

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