Post-pandemic, inflation has started to rise. The Consumer Price Index in the US rose by 6.2 per cent in 2021 compared to last year — highest in three decades. European Union’s inflation at 4.1 per cent in the same month was a 13-year high and more than double its well enshrined target of 2 per cent. UK’s inflation too is a decade high at 4.2 per cent.
How the major economies have reacted
- With inflation remaining firm in the US, Fed is under pressure to act. It has announced that it will reduce its bond purchases that ensured a loose monetary policy.
- The US’ Federal Reserve (Fed) is maintaining that this inflation is ‘transitory’ and caused by supply-chain bottlenecks created by Covid.
- European Central Bank (ECB) too has taken a similar stand.
How will high inflation in developed countries impact emerging markets?
- Persistent high inflation will force them to increase interest rates and such a move may impact emerging markets including India.
- Foreign portfolio investors pumped in as much as $37 billion into India in FY21 alone in search of better returns. Increase in interest rates in the US or Europe will cause some of them to shift to those markets. This could trigger a sell-off in the markets.
- Taking advantage of low (or near zero) interest rates Indian companies have borrowed as much as $130 billion in the last five years. These borrowings could turn costly and future external commercial borrowings could become unattractive.
- If the dollar outflow is heavy and inflow drops, rupee could come under pressure. A weakened rupee (along with high fuel prices) could fuel domestic inflation and smother economic growth.
- Strong dollar and a weakened rupee can increase the import bill as the quantity of crude oil we import is staggeringly high
- Even though rupee getting weak can increase the exports, high inflation + increased interest rates in developed countries can reduce their spending capacity, causing a slump in India’s exports
Though inflation is in control in India, other emerging countries are already grappling with rising inflation. Brazil’s inflation is 10.67 per cent while Turkey’s has touched almost 20 per cent. Argentina is seeing a runaway inflation in excess of 50 per cent and in Russia it is 8.1 per cent.
How to structure:
- Give a brief introduction about inflation
- Explain how the effects of abrupt inflation in developed economies. Focus on how the interest rates are modified, value of currency is affected, spending characteristics are changed etc.
- Now focus on how the above changes affect developing economies like India
- Suggest way forward and conclude