RBI must assess impact before rate change

Markets are sweating bullets over a global banking crisis, but central banks continue to keep an eagle eye on inflation. The string of rate hikes this week by the US Federal Reserve, followed by European policymakers including the UK, Norway, Switzerland and Sweden, confirms that, for now, inflation remains the chief destroyer of all global economic ills. Such steadfastness relegates the ongoing struggles of banks and financial institutions due to rising interest rates as pretty harmless and mostly market imagination. According to a Reuters calculation, ten developed economies have raised rates by 3,290 bps, or a staggering 33%, in this cycle that began last year. Trendsetter US even saw the steepest hikes in over four decades. Such aggressive tightening only implies that the biggest challenge will be ensuring that rate hikes don’t destroy economic growth or employment. Fine-tuning policy rates isn’t as easy as it sounds, and precisely for this reason, they are considered a blunt tool. Regardless of the central bankers’ assurances, avoiding a rolling recession, where the downturn affects sectors unequally, is as good as believing that the best weatherman can stop the storm.

Global oil prices are moderating, and accordingly, the medium- term inflation outlook for most economies is expected to ease. It means external cost pressures are waning, but domestic wage-price pressures remain elevated, forcing central banks to maintain their vigil on prices, tight labour market conditions, wage growth and services inflation. Another major source of uncertainty includes the pass-through of global shocks and their unwinding. For instance, the unprecedented sequence of domestic and global shocks makes it challenging to distinguish supply-demand imbalances triggered by the pandemic and energy crisis from persistent, self-sustained inflationary dynamics, as the European Central Bank noted.

Like others, the RBI, too, is caught between the risk of underreacting and overreacting to the inflationary dynamics. Given it declared its intent to remain data-dependent more than once, RBI must urgently shift its policy stance to neutral, which helps avoid pre-committing rate hikes or cuts. It should assess the impact of its tightening, which is acutely being felt on outstanding housing loans and others. To note the central banking’s separation principle, delivering the appropriate policy stance shouldn’t come at the cost of impairing its transmission.