US inflation and impact on India

Subject – Economy

Context – On Wednesday, the United States’ Labor Department reported that retail inflation had spiked to 6.2 per cent in October.

Concept –

What is inflation rate?

It is the rate at which prices increase over a given period.
Typically, in India, the inflation rate is calculated on a year-on-year basis.
- In other words, if the inflation rate for a particular month is 10 per cent, it means that the prices in that month were 10 per cent more than the prices in the same month a year earlier.
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?

On the face of it, Indians may not find a 6.2 per cent inflation rate a very sharp increase in prices.
But in the US, this data is the largest year-on-year increase in the last three decades.
Another way to put this data in perspective is that the Federal Reserve (or Fed), the US central bank, targets an inflation rate of just 2 per cent.
- Seen in that context, it is clear why the US inflation rate has become a massive concern for its citizens.

What is happening in India?

While most other economies were surprised by a spike in inflation in the wake of the pandemic, India was one of those rare major economies where high inflation predates the pandemic.
As the chart shows, 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.

Impact on India –

When prices increase globally, it will lead to higher imported inflation. In other words, everything that India and Indians import will become costlier.
High inflation in the advanced economies, especially the US, will likely force their central banks, especially the Fed, 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.
- That, in turn, may further raise inflation because the production costs would go up.