US inflation and its Effect on the Indian Economy

The beginning of the Covid-19 pandemic caused great damage to the world economy. After a few months, nonetheless, some of the individual economies began to show signs of recovery. However, many distortions got deeply rooted in the economic structures around the world. The United States of America, the world’s largest economy, is going through one of its worst inflations since last year due to some of these distortions. Furthermore, many other disturbances in the country’s economy and disruptions around the world intensified the inflation in the US during the last year. The inflation rate breached the Federal Reserve’s recommended upper limit of 2% last year in March and has been constantly increasing since then. According to the US Bureau of Labor Statistics, consumer prices for all items increased by 8.6% in the period of May 2021 to May 2022 which is the largest 12-month increase since 1981. These rates are alarming for the entire world and not just the US. According to a survey conducted by Financial Times in collaboration with the Initiative on Global Markets at the University of Chicago’s Booth School of Business, many leading academic economists have predicted that the US will enter a recession in 2023.

There were many combinations of economic snarls around the country and the world that led the US to its current situation. After going through the most difficult patch of the pandemic, the economy began to trace back its path to normalcy as more people began to take up jobs and earn wage gains. Consumer demand began to grow at an increasing rate. However, due to the decline in production during the pandemic, the supply of goods fell short of the demand. This demand-supply mismatch instigated a price rise by the industries in various sectors. The situation has been worsened by the recent lockdowns in China which gave rise to many supply chain problems. The US also saw a new high in fuel prices which is a consequence of the ongoing Russia-Ukraine conflict. The rise in the price of gas set in motion a domino effect that increased the price of almost every good and service in the country. The spending of people is also shifting towards the service sector in an attempt to return to a pre-pandemic life, thus creating inflation in the service sector too. Consequently, there has been a surge in the prices of food, airline tickets, housing, hotels etc. The world economies are keeping a close watch on the situation in the US as the fears of a recession are mounting because the recession, coupled with other major events around the world, is likely to affect almost every economy around the world, including India.

Due to the increasing trade ties and interconnectedness between India and the US, markets in India are likely to be greatly affected by the ongoing inflation in the US. India itself is under the burden of rising prices. The inflation rate based on CPI, according to the Ministry of Statistics and Programme Implementation, in the month of June stood at 7.01%. To tackle inflation, the US Federal Reserve has already announced hikes in the interest rates and some more such announcements are expected to come in the near future as well. These interest rate hikes are likely to hurt the capital flows to India, and other developing economies. In India, the demand has still not returned to its pre-covid level. Consequently, the pertaining inflation will make it more difficult for the economy to return to normal levels.

The US is India’s one of the biggest trade partners. Therefore, there are fears of inflation getting imported to India. The price rise in the US will make India’s imports from the US more expensive, as a result of which prices will further rise in India, pushing the current inflation rate to an even higher level. The already rising fuel prices will skyrocket in almost no time making every other good and service in the economy more expensive. Another problem facing the Indian economy would be the loss of Foreign Portfolio Investors (FPI). A hike in interest rates by the Federal Reserve in the US will encourage more capital to be kept in the US banks. In return, the Reserve Bank of India (RBI) will be required to raise the interest rates domestically to adjust to the rising prices in the world economy. This might have adverse effects on trade and might end up hurting economic growth. Another concern for the Indian economy due to the FPIs pulling out of bonds and equities would be the depreciation of the Indian rupee. The Indian rupee has reached its all-time lowest value compared to the US Dollar and is expected to depreciate further. The current value of INR is lower than the earlier expectations which will result in higher inflation than expected. The RBI is taking every possible step to slow down the fall in the value of the Indian rupee and reduce the volatility in the economy.

The world economic systems have now become more interconnected than ever. The world’s largest economy, though tackling slow economic growth in the past few years, still remains at the centre of most monetary and financial institutions around the globe and has the power to influence every economy. Therefore, the growing fears of a recession in the US, combined with the events like the Russia-Ukraine war, the far from over Covid-19 pandemic and consequent lockdowns in China, are likely to pose plenty of challenges to both advanced and emerging countries around the world.

 

Anurag Tiwari

Research Intern at CPRG