What India can do about its low inflation problem

By Daniel Moss

India’s economy, so often touted for potential to supplant China as a global engine, is having a hard time getting its arms around inflation. Not that it's too high, but because the pace of price increases is worryingly low. Fixing this will require more than the standard prescription — simply cutting interest rates. The promise of an aggressive and sustained easing is needed, one that brings its own share of challenges.

This will be tough for Reserve Bank of India Governor Sanjay Malhotra to get right. Markets already appreciate the need for a change. The rupee is the worst-performing Asian currency this year against the dollar and, on Friday, it fell to a record low. Traders attributed at least part of the slide to the RBI's reluctance to intervene, breaking with the practice of recent months as the currency weakened largely because of an elusive trade deal with the US. The bank's absence may be a strong signal that a policy shift is in the wings; lower borrowing costs tend to weigh on a currency. (The central bank returned to the market on Monday.)

For Malhotra, this could be a Janet Yellen moment. For years after the end of the Global Financial Crisis, inflation failed to pick up in the US and was, in the view of the-then Federal Reserve chair, a little too low for comfort. Asked why inflation remained stubbornly low, she conceded in 2017 that it was a “mystery.” Two years later, her successor, Jerome Powell, called the phenomenon “one of the major challenges of our time.” It took Covid, massive fiscal stimulus, and the supply chain pressures the pandemic uncorked for inflation to awaken.

Humility regarding India's projections is in order. The central bank's forecasts have consistently overestimated inflation. A surprisingly low reading for October means forecasts of 2.6 per cent for the year to March are already looking out of date. And that call was made as recently as last month. Considering the bank's target is 4 per cent, policy is now way too tight.

Inflation in India is slowing considerably

The moment calls for boldness. The RBI should embrace the low-inflation environment when its committee meets in two weeks. At the prior gathering in early October, the bank emphasised prudence and a neutral stance, one that neither holds the economy back nor stimulates it. It's now time to shift to an “accommodative” posture, according to Bloomberg Economics. This would tell investors and consumers that Malhotra's strong preference is to keep cutting. After a period of excessive caution, the RBI should let its hair down a bit. It would also help growth, which has been faltering.

Recognising that inflation isn't the threat it was comes with its own dangers. The rupee is likely to come under further pressure. Sure, the RBI could pair its change in rate outlook with more intervention. This should be restricted to what central banks and finance ministries like to call “smoothing” - not standing totally against the market, but watching that things don't get out of hand. To be more aggressive would risk looking like authorities are conflicted, recognizing the need for easier money, but unwilling to embrace the full implications.

And there's more ailing the rupee than the rate picture. Malhotra recently said that securing a good trade deal with the US would bring money back to India's currency. The US currently levies 50 per cent tariffs on Indian exports, the harshest among Asian nations. Assuming an accord is reached sooner or later, the definition of “good” will be in the eye of the beholder. Southeast Asian nations, for example, got a reduced levy, but agreed to certain American priorities, some aimed at constraining China. Whatever agreement Prime Minister Narendra Modi hatches with US President Donald Trump has to be sold domestically. It could be messy.

The RBI can't control this. It can, however, attend to matters on its own patch. Acknowledging the inflation miss is part of that. Doing something about the problem, and adjusting mindsets to avoid repeating it, is critical. December's meeting is shaping up as eventful. In that, there should be little mystery.

(Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.)