Controlling Inflation in De-globalizing World: A Real Test for RBI’s Policy
-Adil Ameen & Disha Aggarwal
Introduction
The dominance of globalization as the sole acceptable economic system of the globe has been threatened in recent times with a dual approach. One is “Deglobalization” characterized by market segregation, and providing favourable conditions for the local economy, while on the other hand “globalization 2.0” argues the existing world economic order is efficient as well as effective in meeting the needs of all mainly that of the people in growing economies.
Globalization refers to the highest degree of integration among the world’s economies and promises an equal playing field for all economies where they can compete. The idea of equality among all the sovereign states irrespective of their economic and military advancement and the notion of world order based on democracy, equality, and liberty resulted in the turning of the world into a global village in which technologies have a Vital impact on such integration. However, the impact of such integration did not match with promised outcome those at the very top of the economic pyramid received the majority of the benefits of globalization.
“China got very rich making cheap stuff … Russia got very rich selling cheap gas to Europe, and Germany got very rich selling expensive stuff produced with cheap gas.” The US, meanwhile, “got very rich by doing QE. But the license for QE came from the ‘low inflation’ regime enabled by cheap exports coming from Russia and China.” Since the majority of economies in the world do not benefit from integrated economic systems i.e Globalization they are considering withdrawal from the system.
The Brexit referendum or the emergence of nationalist parties across the globe and other such political trends across Europe and America is the starting point of a deglobalization process all around the world. The Pioneer in this transition is the same that led the globalization movement across the globe i.e USA being followed by other countries. The catalyst in this regard is the Great Recession of 2008 and the lockdowns of the COVID-19 pandemic all across the globe. While losses caused by the crisis of 2008 were being recovered the pandemic forced for involuntary segregation of economies. For States National security, public health, medical utilities, food, and emphasis on local production became prime concerns in the absence of cooperation among nations forced to reduce economic interdependence.
“Deglobalization” is used to indicate the process of the deconstruction of the system of globalization characterized as a process of diminishing economic interdependence and integration between states. It is regarded as a tool for developing states to promote their local interests. The reasons of which range from economic crises to a fall in demand in the global market, natural disasters, and armed conflicts. It is prompted by the Failure of globalization to answer crucial questions of economies like poverty, unemployment, and destruction of the economic system.
In this scenario of disintegration and segregation of economies of the world rising inflation across the nation has emerged as the biggest challenge due to various restrictions in global trade. Globalization has helped in controlling inflation due to the easy availability of raw materials and the labour force. This challenge was acknowledged by the RBI governor in words:
Stories of other developing countries are similar to the inflation rate of Sri Lanka Which was 6.15% at the outset of the pandemic and reached 49.72% in 2021 while Brazil’s inflation rate reached 9.28% in 2022 which was 3.21% in 2020.
Unlike developed nations where they face the threat of recession, the Indian economy’s prime macroeconomic objective is controlling inflation and fostering rapid growth and this makes the case of India unique in an era of growing deglobalization of trade to balance rapid economic growth while keeping inflation in control.
Ways that deglobalization might affect India’s inflation
- Imported inflation
One of the main ways that deglobalization might affect India’s inflation is through imported inflation. India’s major imports include necessities like electronics, machinery, pharmaceuticals, and crude oil. As a result of protectionist policy, the cost of imported goods could go up. This is crucial in the case of oil since India imports a significant amount of oil to meet its energy needs.
2. Impact on supply chain
India’s efforts to localize production and lessen its reliance on global supply chains may initially experience transitional setbacks. These interruptions can include infrastructure and industrial process changes, as well as logistical difficulties. These hiccups may cause brief product shortages and supply-side constraints, which will put increased pressure on prices.
3. Impact on exchange rate
Deglobalization may also affect the dynamics of the exchange rate, which may have an impact on India’s inflation. The value of the Indian rupee can be impacted by changes in trade relations and policies. If imports drastically drop, a move toward protectionism could result in a stronger rupee. While a higher rupee may be beneficial for containing imported inflation, it may also have unfavourable effects, such as lowering the competitiveness of Indian exports on the international market, which could impede economic progress. Therefore, the overall impact of exchange rate fluctuations on inflation depends on their net impacts on imports and exports.
4. Impact on production cost and consumer behaviour
Industries may incur greater expenditures due to the deglobalization initiative’s shift toward domestic production. Higher labour expenses, compliance with domestic legislation, and investments in new production facilities can all result in higher production costs causing inflation. Consumer preferences and readiness to pay potentially higher costs for domestically produced items are key factors in the success of “Vocal for Local” and similar initiatives that support local products. Strong consumer support for locally produced goods may result in higher prices and more demand, which would boost inflation
5. Impact global economic factor and export implication
Since India is a vital component of the global economy, external variables like commodities prices internationally and general economic conditions can have an impact on local inflation. While domestic production and consumption are the main focus of deglobalization initiatives, global influences can still have a sizable impact. For example, changes in the price of raw materials and energy may have an impact on inflation through reverberating through the Indian economy. Deglobalization primarily aims to lower imports, but it can also have an impact on India’s exports. India’s ability to compete internationally may suffer if trading partners retaliate against protectionist policies with their trade restrictions. A decline in exports may slow India’s economic expansion and increase the risk of inflation as companies struggle with lower sales.
The changing character of the Russia-Ukraine war has drastically impacted supply-side disruptions in the post-pandemic world that were merely going through a nascent recovery from economic shocks, raising concerns about higher inflation among central banks around the world, including India. The substantial rise in expenditure by the government during the pandemic unmatching with a proportionate increase in the production of goods and services has raised a red flag regarding resulting inflation in the economy. Public expenditure by the government at the time of the pandemic has put fiscal pressure on the government even though tax revenues are booming and partly driven by inflation.
Reserve Bank of India Takes care of the delicate task of controlling inflation by periodically revision the monetary policy of the country which in August 2023 reaffirmed its commitment to bringing inflation back to 4% on a sustained basis while Inflation is projected to be 5.6% on average throughout FY24. The change in the price of agricultural products and, to a lesser extent, imported oil is what causes inflation in India. Both the price of food and the price of imported oil are outside the control of the monetary policy RBI. In theory, the way for monetary policy to manage inflation is to slow the expansion of non-agricultural output, which would therefore slow the expansion of demand for agricultural products. Inflation will drop along with the decline in demand for agricultural products, but output and employment will suffer as a result.
Union Finance Minister N. Sitharaman, remarked, that monetary policy acting alone could be an ineffectual tool for taming inflation in the Indian context.
Though a reduction in the excise tax on petrol and diesel helped to slow the rise in prices, inflation has continued at a galloping rate. As supply was unable to keep up with demand, the rebound was accompanied by an increase in commodity prices worldwide. The conflict’s onset accelerated the commodity upcycle and nearly destroyed the supply side for essential items like crude oil and metals, which India imports in large quantities and is crucial. Recently, a group of RBI’s economists expressed their opinion that the fight against inflation will be arduous and protracted. We have made good progress in sustaining India’s growth momentum. While inflation has moderated, the job is still not done. Inflationary risks persist amidst volatile international food and energy prices, lingering geopolitical tensions, and weather-related uncertainties.
Suggestion
It’s possible to boost foreign investor confidence while maintaining the momentum of growing economies by directionally raising interest rates and doing so gradually. This new challenge requires a holistic approach much more than monetary policy as both inflation and Deglobalization are coincident. The reluctance to substantially lower the interest rate of RBI is caused by the need to balance the risk perceptions of foreign investors, whose exit could lead to a decline in the value of the rupee, with the need to retain a buffer for higher levels of inflation in India. In comparison to worldwide trends, the cost of a slower interest rate increase is the potential loss of foreign exchange reserves as the foreign investor will be attracted towards other economies if they have a low-interest rate there. This is because foreign exchange reserves will be used to combat currency depreciation that will occur once the cautious foreign investors go due to the potential high inflation, unchecked budget deficits, and expanding current account deficits that may occur in the future.
In times of economic uncertainty, financial markets can be highly volatile. Strong regulations can prevent speculative bubbles and ensure the stability of the financial sector, preventing financial crises that could lead to inflation. Provisions to maintain sufficient capital buffers to absorb sudden shock, transparency, and discloser provisions, fair lending to prohibit predatory lending and financial fraud, a dedicated resolution authority with the power to resolve failing financial institutions timely and efficiently, and regular stress tests on financial institutions to evaluate their resilience can be proactive measure for upcoming challenges.
In addition to RBI’s Policy control other measures become quite necessary for this peculiar economic situation. In a deglobalizing world, relying on a few trading partners can be risky hence diversification of trade partners can mitigate inflationary pressures caused by disruptions in any single market. The government policy of ‘ATMNIRBHAR BHARAT’ becomes crucial concerning the globalizing world which advocates for Subsidies, tax incentives, and supportive policies that can encourage businesses to produce locally, reducing dependency on imported goods and minimizing the impact of global price fluctuations. India’s role in producing a supply of vaccines post-COVID era is proof of its capability and has shown the path for the future course as once we are self-reliant can do better for the world. Agriculture plays a significant role in India’s economy. Stable food prices can prevent spikes in inflation, especially in developing countries like India, where food costs significantly affect the inflation rate.
In a deglobalizing world, supply chains become shorter but can also become more volatile. Constant vigilance on supply chain disruptions can help anticipate shortages and price fluctuations. Swift and strategic actions can be taken to stabilize essential goods’ prices
The role of RBI through its monetary policy is very limited in solving the challenges of deglobalization in India. Though external factors are involved in deglobalization, the role played by the RBI is a matter of appreciation. Also, the fiscal measures have to be coupled with the monetary measures to effectively face the challenges and opportunities of deglobalization for India. Adaptability and a keen understanding of global economic dynamics will be key to ensuring economic stability and sustainable growth in this changing landscape.
The authors are students of Chanakya National Law University, Patna.