Low interest rates. Why the era of low interest is rates over?

What is causing inflation to rise in India? 

Global commodity price inflation has been building up since the last quarter of 2021 due to rising demand, as consumption increases with ebbing Covid cases. The Russian invasion of Ukraine has worsened the situation, with Brent crude oil prices crossing $120 per barrel in March. Crude oil prices have been holding above $100 per barrel since then, sending fuel costs shooting higher.  

With the US and its allies making it difficult to access exports from Russia, prices of agri commodities such as wheat and edible oil as well as metals have also surged. The situation has worsened with China imposing lockdowns in April to control Covid-19 cases. This affected global supply further. The rupee hitting an all-time low against the dollar has increased the cost of imported goods further. 

The targeted rate for consumer price inflation set by the RBI is 4 per cent, with 2 per cent leeway on either side; the fitment band is, therefore, between 2 and 6 per cent. Panic has been building up about rising inflation because the upper limit of 6 per cent has been breached for four consecutive months now, and the April reading of 7.79 per cent is at an eight-year high. 

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Is the CPI becoming more broad-based now? 

The problem is that Indian companies are now beginning to pass on higher input costs to their customers in the form of higher prices of goods and services. This is leading to price increases in almost all segments. For instance, while food inflation was 8.38 per cent, inflation in transportation and communication was 11 per cent. The cost of heathcare (7.21 per cent), clothing and footwear (9.85 per cent) and personal care products (8.62 per cent) are also going up steeply, hurting the wallets of the common man. 

Core inflation, excluding food and fuel, was 7.35 per cent in April 2022. Core inflation is more difficult to bring down and poses a greater problem to regulators. 

Is it a global phenomenon? 

Yes, all countries are in the same boat since the pandemic has impacted supply in all countries and the disruption caused by the Russia-Ukraine conflict and China’s lockdown has led to severe shortages in agri and other commodities globally. 

CPI inflation in the US, at 8.5 per cent in March, was at a 40-year high. It’s due to the higher degree of uncertainties caused by recent global events that the IMF has revised the inflation projection for 2022 to 5.7 per cent for advanced economies and 8.7 per cent for developing economies in the April World Economic Outlook. 

How are RBI and other central banks reacting to this situation? 

Global central banks are on the war-path to control inflation now; for, a sustained increase in price increases the risk of stagflation wherein there is an extended period of high inflation and low growth in the economy. 

While there is little that can be done to ease the supply-led inflation by central banks, they are trying to control demand and thus cool prices. Demand has been boosted by the easy monetary policies adopted by central banks to fight the pandemic-led slowdown in 2020. These easy policies include excessive money pumped into the system by global central banks and ultra-low interest rates since April 2020.  

Central banks, including the US Federal Reserve, RBI and Bank of England, are now beginning to increase interest rates and reduce liquidity in the system by reducing the bonds issued by them. 

Will tightening monetary policy across the world smother economic growth? 

There is certainly a risk that some near-term growth will be sacrificed due to liquidity tightening and interest rate hikes. Companies that were beginning to plan for capital expansion will postpone their plans and wait for better visibility on the rate hike cycle now. Consumers will also postpone their discretionary spends as their outgo on essentials such as food and commute increases. Real estate, consumer durables, travel, etc, may get impacted as interest rates on loans begin moving higher. 

GDP growth projections for India as well as other countries have been revised lower for 2022 as the world grapples with high inflation. 

Is the era of low interest rates over? 

When the economy is in extreme distress, lowering the interest rate is one of the ways to ward off recession. In the recent past, ultra-low interest rates were prevalent after the global financial crisis in 2008, and following the pandemic in 2020. As growth revives, these rates need to move back to the mean. So, yes, the era of low interest rates is over.

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