Editorial 1: Forecast is still cloudy: Inflation is down but RBI remains vigilant
Recent Context:
- Recently, he Monetary Policy Committee of the Reserve Bank of India (RBI) has preferred to stand put than surprise the way it did in April.
- The inflation print for the last two months seems to indicate that the peak has been passed:
- The wholesale price index (WPI) inflation fell to -0.9 per cent in April from 1.3 per cent in March, while the consumer price index (CPI) inflation declined to 4.7 per cent from 5.7 per cent. It is expected the pause to continue through 2023.
- The RBI has communicated that its fight against inflation is not over till it is aligned with its target of 4 per cent on a durable basis. This implies it will not be in a hurry to cut rates.
International scenario of monetary policy:
- In the US, tightening financial conditions, amid the banking stress, helped the Federal Reserve (Fed) by creating a downside to growth and inflation. The enduring gap between Fed’s communication and market expectation is narrowing which is expected to sustain the economic growth for longer duration
- In Europe, however, core inflation has been quite sticky, and the European Central Bank is likely to continue raising rates. Interestingly, the Bank of Canada and the Reserve Bank of Australia raised interest rates in June. On the other hand, most emerging markets have seen the peak of the rate hiking cycle.
Inflation and its causes in India
- In India, a sharper-than-anticipated decline in inflation in March and April was driven by base effect and a correction in commodity prices which had spiked due to the Russia-Ukraine conflict last year, creating a favourable statistical base effect.
- Although the favourable base effect will fade over the next few months, we expect consumer inflation to average 5 per cent this fiscal as compared to 6.7 per cent last fiscal.
Favorable monsoon and lowering fuel price will help in controlling inflation
- In May, the India Meteorological Department reiterated its normal monsoon forecast. So, assuming a normal monsoon, we expect food inflation to soften. As Normal monsoons are important for a durable decline in cereal inflation, which is currently in double digits and has a high weight in consumer prices
- It would be the fifth successive normal monsoon if it does turn out to be one. That is a rarity.
- With climate change at play, monsoons can always throw a curveball. Plus, the Australian Bureau of Meteorology recently elevated the El Nino watch to the “alert” category, indicating a 70 per cent chance of El Nino this year.
- Fuel inflation is already heading down and will come down further as global crude prices will be lower compared with last fiscal. We expect the per-barrel brent price at $80-85 this fiscal year compared to $95 in the previous one.
Goods versus services inflation and situation of Economic growth:
- Another interesting feature of inflation dynamics is the goods versus services inflation. Goods inflation has corrected more than services inflation.
- Historically, service inflation has been higher than goods inflation. During the pandemic, due to reduced demand for services, its inflation stayed lower than goods inflation, which had spiked due to the supply shock amid continued demand for manufacturing products.
- Demand for services such as airlines and hospitality has turned fast and furious with the withdrawal of Covid-induced restrictions and this is pushing up their prices. Concomitantly, the correction of commodity prices has dragged WPI into deflation territory and will help soften consumer price inflation with a lag.
- As per S&P Global’s Purchasing Manager Index (PMI), both manufacturing and services remained robust in the first two months of this quarter. Between April and May, the manufacturing PMI rose from 57.2 to 58.7, while for services, it was above 60 in both month
- The numbers for 2022-23 show consumption and investment activity were quite robust, outpacing overall GDP growth.
- While investment remained strong for all four quarters of last year, private consumption slowed down towards the second half. We expect investment momentum to continue this fiscal and private consumption to be a tad slower compared to last year.
- Housing and auto loans have already risen past pre-pandemic levels and given that some transmission of the rate hikes is yet to play out, activity would moderate down the road
Conclusion:
- Recently, Monetary Policy committee (MPC) stays the repo rate as previous one which will help in controlling the food and fuel-based inflation along with maintaining economic growth.
Editorial 2: The US-China thaw
Recent Context:
- Recently Indian Prime Minister is going to visit USA, June 21-24 and both nations are said to be looking at “consecrating” their relationship premised on greater alignment of goals in Asia and the Indo-Pacific.
- At the same time, the US appears to be inching towards a detente with China. After months of trying which is seen as attempt of USA Administration to ease strained ties with China.
US outreach efforts
- Blinken, Secretary of State of USA called off a scheduled visit to China in February after a Chinese high-altitude balloon appeared above the US and was ultimately shot down on President Joe Biden’s orders.
- The Pentagon said the balloon was a spying device, while China claimed it was a research airship that had blown off-course.
- US-China tensions have been high since the time of the Covid-19 outbreak. China’s suspicion that the Quadrilateral Security Dialogue is a mechanism to contain it in the Indo-Pacific, and the proactive US positioning on Taiwan — with then Speaker Nancy Pelosi’s August 2022 visit — did not help matters.
- But over the last couple of months, the US has made efforts to reschedule Blinken’s visit even as the Chinese have played hard to get. At the annual Shangri La Dialogue last week, Chinese Defence Minister Li Shangfu whom the US has sanctioned refused a meeting with Defense Secretary Lloyd Austin.
- In a background press briefing, a senior White House official said both sides “have sought to increase high-level engagement in order to maintain channels of communication” and “manage competition”. US is “in competition” with China, but it “does not seek conflict or confrontation
Shape of the détente
- The détente, as it came to be called, reduced tensions and led to a period of cooperation, even as proxy conflicts played out in the superpowers’ respective spheres of influence.
- During the Cold War, the US and USSR worked out a modus vivendi after coming close to a nuclear conflict during the 1962 Cuban missile crisis.
- Cold War strategist Henry Kissinger, one of the architects of the original détente, suggested that an accommodation with China might look very similar to the one the US reached with the Soviet Union.
- Economic engagement forms a substantial part of the US-China relationship.
- Bilateral trade was almost $700 billion in 2022. The US imports more from China than any other country. American companies have long seen China as a top investment destination, although that may be changing now.
The view from India
- Over the last few years, the US and India have grown closer over a shared perception of China’s rise. India’s embrace of Quad and the US Indo-Pacific strategy came after the Doklam standoff in 2018 and the PLA incursions into eastern Ladakh in 2020.
- The US sees India as a major part of its endeavour to build a regional coalition against China. But how would an improvement in US-China relations play out in a region where India is the country with the longest land border with China
- Former Ambassador to China Ashok Kantha said India cannot let its broad-spectrum strategic partnership with the US be defined primarily by China
- As differences between the US and China were deep-rooted and fundamental, he said: “Any attempt at accommodation can only be limited to tactical measures, putting in place guardrails and reducing the risk of military conflict which neither side wants. Neither is interested in addressing structural problems in the relationship.”
Conclusion:
- India needs a counterbalancing strategy vis-à-vis China, which will involve working with the US and others with shared concerns about the country while retaining its own agency.
- There has to be clarity on the limitations of such strategic alignment, how far India is willing to go, and how to manage expectations on both sides