Impact of US inflation in India: Relevance
- GS 2: Effect of policies and politics of developed and developing countries on India’s interests, Indian diaspora.
US inflation impact on India: Context
- Recently, retail inflation in US had spiked to 6.2%. On Friday, India’s National Statistical Office (NSO) data showed that retail inflation rose to 4.5 per cent for the same month.
- A high inflation rate erodes the purchasing power of people. Since the poor have less money to withstand fast-rising prices, high inflation hurts them the hardest.
Why is US inflation a matter of concern?
- While India may not find an increase of 6% a very sharp increase, it is a matter of concern for US as the US Central Bank targets an inflation rate of just 2%.
- Retail inflation in the US has been rising sharply almost every passing month since May 2020.
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What has caused the inflation surge in the US?
- Inflation typically takes place due to supply and demand factors and in the US, both these factors are responsible for the spike.
- Thanks to a rapid rollout of the Covid-19 vaccination drive, the US economy posted a sharp recovery. Part of the inflationary spike came from the unexpectedly fast recovery from COVID-19 owing to the rapid rollout of vaccination drive.
- This recovery was further fuelled by billions of dollars pumped by the government to not only provide relief to consumers and those who lost their jobs, but also to stimulate demand.
- The pace of economic recovery has been much faster than the supply chain recovery, and this has worsened the mismatch between demand and supply, thus triggering a sustained price rise.
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Is this a US-specific phenomenon?
- While the US has seen the sharpest increase in prices, inflation has surprised policymakers across most of the major economies, including Germany, China or Japan.
- In Japan, for example, according to Bloomberg, the producer price index is at a 40-year high.
Causes of inflation in India 2021: What is happening in India?
- India is one of those rare major economies where high inflation predates the pandemic.
- Retail inflation had frequently been above the comfort zone of the Reserve Bank of India (RBI) — between 2 per cent and 6 per cent — for an extended period since late 2019.
- The pandemic did make matters worse because of supply constraints even when in India demand has not yet recovered to pre-Covid levels.
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Effect of US inflation on Indian
- When prices increase globally, it will lead to higher imported inflation, which will further increase our current account deficit.
- High inflation in the advanced economies, especially the US, will likely force their central banks, to abandon their loose monetary policy.
- A tight money policy by the Fed and the rest would imply higher interest rates.
- That will affect the Indian economy in two broad ways.
- One, Indian firms trying to raise money outside India will find it costlier to do so.
- Two, the RBI will have to align its monetary policy at home by raising interest rates domestically.
Effect of US inflation on Indian stock market
- Market value stocks prices are usually directly proportional to the rate of inflation
- Therefore, when the inflation rate rises, value stocks tend to perform better.
- Hence, during the times when inflation goes up, investors must not panic so as to avoid emotion-based decisions.