The US Federal Reserve is likely to hike the interest rate by 25 basis points after its Federal Open Markets Committee (FOMC) meeting spanning two days started yesterday (25th July), as its aim of containing inflation to 2 percent hasn’t been achieved yet.

At the same time economists are sounding a word of caution--the side effect of hike would be growth becoming a casualty and with it employment opportunities. This is the classic dilemma of central bankers the world over--you suck liquidity in the system by hiking interest rates the inflation may come down but growth will take a backseat as many economies have found to their dismay.

Most market observants wistfully expect Fed to end its most aggressive fight against US inflation in 40 years in July. It means the 16-month hiking cycle that began in March 2022 could end in July 2023 with rates rising from near zero levels to a range of 5.25 percent to 5.5 percent, the highest since 2001.

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One however needs to keep his fingers crossed. The US job market isn’t in good shape. So, the US Fed must be on the horns of a serious dilemma. It should not lose in the swings (employment) what it has won in the roundabout. The US economy is dependent on immigrant workers both blue and white collar, and it cannot afford to disappoint them.

India’s RBI too has pressed the pause button, and it may be tempted to follow its US counterpart when its MPC meets next from 8th to 10th August but it should ponder seriously before doing so. India and the US are not on all fours. US economy is not characterised by shortages especially on the food front whereas the Indian economy is, thanks largely to the vagaries of nature which makes its food prices, especially potato, tomato and onion, swing widely and egregiously seasonally.

The point is the Indian inflation is largely due to supply side constraints which must be addressed instead of hoping in vain that making money dearer would contain inflation.

That in the US, the conscious policy of dear money has worked is borne out by the fact there is a marked slowdown in the rate of the consumer price index -– from about 9 percent a year ago to 3 percent now but along with a sharp drop in spending by consumers, a cooling labour market and a serious decline in manufacturing activity. But each economy has its own peculiar and unique characteristics, and it would be foolish to ape what other central bankers are doing.

The US financial system is dominated by credit card spends in particular and banking channels in general. So, any change in interest rates has the desired pass-on or percolation effect even though admittedly it has no impact on dollars in circulation outside the US which is guesstimated to be 50 percent of the total greenback in circulation. But the Indian economy is a different kettle of fish, with cash still ruling the roost though not on a scale earlier.

Therefore, in the next Monetary Policy Committee (MPC) meeting of the RBI slated for 8th to 10th August, the Indian central bank must look for a sui generis or unique solutions tailor made for the Indian economy and is financial system.

It is no use tinkering with the interest rates when the monster of inflation needs to be contained with supply side initiatives. Cold storages and food processing industries can neutralise seasonal vagaries to a great extent as evident from the US market. These two industries need to take firmer and deeper roots in India so as to iron out seasonal fluctuations of food prices. But India has done well to wean away farmers from cereals to lentils but more needs to be done.

— The author, S Murlidharan, is a CA by qualification, and writes on economic issues, fiscal and commercial laws. The views expressed are personal.

Read his previous columns here

(Edited by : C H Unnikrishnan)

First Published:Jul 26, 2023 11:37 AM IST