Dynamics of Inflation in South Asia1
Good afternoon and a warm welcome to South Asian Association for
Regional Cooperation (SAARC) central bank colleagues participating in
this first physical seminar under the aegis of SAARCFINANCE after the
onset of the pandemic.
Greetings to Ms. Dechen Pelzom, Executive Director, Royal Monetary
Authority of Bhutan.
We are delighted to have with us colleagues from the Ministry of Finance,
and virtual participants from our central banks, the Bank for International
Settlements (BIS) and the International Monetary Fund (IMF). I am joined
in our appreciation of your participation by colleagues from the Reserve
Bank of India (RBI) representing various departments.
This Seminar marks the fulfilment of the commitment made by India in the
41st meeting of the SAARCFINANCE Governor's Group in March 2021.
Given the developments in our countries and the global inflation crisis
gripping the world around us, the seminar's theme - the Dynamics of
Inflation and its Control in South Asia - could not have been more timely
and relevant. From a broader perspective, seminars and workshops of
this type under the mandate of SAARCFINANCE have proved to be an
effective avenue for intensifying our engagement through sharing of
knowledge and experiences as well as by energising person-to-person
interactions. Our next seminar will be on the SAARCFINANCE database,
which will be hosted by the Maldives Monetary Authority.
SAARC: Our History
By way of historical background, the South Asian Association of Regional
Cooperation (SAARC) was created in 1985 as an expression of the
collective desire for fostering shared understanding and collaboration in
our region. At present, Afghanistan, Bangladesh, Bhutan, India, Nepal,
Maldives, Pakistan and Sri Lanka are members of the SAARC.
Over the years, our countries have developed strong linkages in the form
of trade, remittances and financial transactions, over and above our strong
cultural ties and shared history. We now look forward to strengthening our
economies with the goal of accelerating economic development and
prosperity by tapping into the full growth potential of the region.
SAARCFINANCE: The Journey
SAARCFINANCE was established in 1998 as a network of our Central
Bank Governors and Finance Secretaries to facilitate dialogue on
macroeconomic policies and the exchange of mutual experiences and
ideas. SAARCFINANCE received formal recognition in January 2002 at
the 11th SAARC Summit held in Kathmandu, Nepal.
Over the last two decades, cooperation between our central banks has
expanded and strengthened. The swap facility, which has been the
cornerstone of this cooperation, has played a vital role in helping to
manage external sector pressures during the pandemic. India has also
extended financial support in the form of a number of credit lines to
SAARC partners.
Policy interface, technical assistance, capacity building and knowledge
exchange have all played a vital role in deepening this engagement. In
particular, research and policy driven collaborative studies, and
symposiums and seminars such as this one, have facilitated this whole
endeavour by bringing about greater appreciation of the issues,
challenges and successes experienced by each country and the region
as a whole.
To cite some fulfilled deliverables under the belt of SAARCFINANCE, the
Governors' Group Meetings have formalised our cooperation and
dialogue on macroeconomic conditions and policies. The
SAARCFINANCE website was developed and launched in 2011. The
SAARCFINANCE Database went live on May 26, 2016 at the Governors'
Symposium held in Mumbai. The first issue of the half-yearly
SAARCFINANCE e-Newsletter was published in December 2006. During
India's Chair in 2020-21, the portal called 'SAARCFINANCE Sync' was
created as a network of connectivity among our central banks. The scope
and coverage of the Scholarship Scheme was expanded by including
more universities, more central banking related courses and by increasing
both the scholarship amounts and the number of scholarships that may
be granted in a year. Efforts have also been made to revamp the
SAARCFINANCE newsletter with a new design and format and by
expanding its ambit to topical articles. Our virtual seminars kept alive our
engagement through the pandemic. The Financial Inclusion Platform, a
repository of initiatives taken by SAARC central banks to promote financial
inclusion and financial literacy, has also facilitated policy making by
enriching it with pan-regional perspectives. The measures we have taken
to deepen cooperation on capacity building are also noteworthy,
especially the collaborative studies on a variety of topics.
Macroeconomic Developments: Opportunities and Challenges
Our countries have come together to jointly fight COVID-19 by
establishing an exclusive SAARC COVID-19 Emergency Fund with
contributions from all members. As a leading producer of vaccines, India
has remained deeply committed to equitable access. India has delivered
vaccines to many SAARC countries within a month from the rollout of its
Vaccine Maitri Initiative in January 2021.
The RBI remains committed to expanding co-operation in the field of
digital banking and finance. Its Payment Vision 2025 envisages global
outreach of our real time gross settlement (RTGS), the National Electronic
Funds Transfer (NEFT), the Unified Payment Interface (UPI) and RuPay
Cards. For instance, Bhutan and India have built cooperation around
RuPay cards so that Bhutanese banks can issue RuPay Cards to their
citizens.
The share of intra-SAARC trade in total exports of SAARC countries has
increased from 6.1 per cent in 2010 to 7.1 per cent in 2020. Similarly, the
share of intra-SAARC trade in total imports of SAARC countries has
increased from 3.6 per cent in 2010 to 5.0 per cent in 2022. The pace of
expansion of trade remains slow, however, even relative to other regional
groupings like ASEAN.
Being severely hit by the pandemic, the region witnessed economic
contraction in 2020. A tenuous recovery coursed through 2021, with
varying degrees of traction and pitfalls across the region. The scars of the
pandemic are still deep and painful in several parts of our region.
In 2022, elevated and persistent inflation has taken hold, threatening to
undermine the nascent progress made in 2021. Several members face
double digit inflation in high reaches. Global spillovers in the form of
exchange rate volatility, elevated commodity prices and supply chain
pressures have exacerbated imported inflation. Since February this year,
shortages of essential commodities and soaring food and energy prices
have threatened livelihood and the welfare of our people.
On the external front, terms of trade shocks and tightening global financial
conditions have translated into wider current account deficits, capital
outflows, high volatility in domestic financial markets and losses of
reserves while amplifying external vulnerabilities. Some of us are also
experiencing debt distress. Access to international financial markets,
constrained by rating downgrades by various external credit rating
agencies, has worsened external liquidity and financing conditions. Some
of us need urgent access to multilateral support in these challenging
conditions.
Theme of the Seminar
The theme of the seminar assumes significance in this milieu. With
inflation broadening across national jurisdictions, repeated shocks
stemming from the outbreak of the pandemic and more recently due to
the war, have translated into an inflation crisis not seen in years.
According to the IMF's World Economic Outlook Update of July 2022,
surging commodity prices and broadening price pressures may cause
inflation to reach 6.6 per cent in 2022 in advanced economies and 9.5 per
cent in emerging market and developing economies, posing a clear and
present danger to macroeconomic stability.
In response, the most synchronised and front-loaded monetary policy
tightening ever seen in decades is underway. Consequently, as liquidity
and monetary conditions harden, the probability of a recession or hard
landing has risen in advanced economies to levels that have preceded
actual recessions in the past. Central banks all over the world are
aggressively striving to regain and entrench their credibility so as to
anchor inflation expectations and bring inflation under control.
Despite the diversity of the South Asian region in terms of country size,
economic and social development, geography, population, trade and
political systems, this daunting spectre of inflation haunts us all. Food is a
large part of our average consumption basket as well as our price indices
- its share in consumer prices ranging across the region between 35 and
47 per cent. South Asia is most vulnerable to food inflation, given the large
segment of our populations battling poverty. Moreover, this is a region in
which it is rising food prices that can trigger second round effects leading
to the generalisation of inflation and its persistence. Furthermore,
dependence on oil imports has made our countries commonly vulnerable
to terms of trade and supply shocks. Consequently, inflation dynamics in
the region show strong co-movements, with common drivers. On the other
hand, our policy frameworks are somewhat diverse, reflecting country-
specific circumstances, and this will condition our approach to controlling
inflation. Our exchange rate regimes also reflect this diversity.
Dealing with the inflation crisis has become complicated as we battle
global spillovers on an ongoing basis. The region now faces a tremendous
developmental challenge within which recovering the losses due to black
swan events like the pandemic look the most formidable. Our countries
have also experienced sharp increases in fiscal deficits and deterioration
of the balance of payments. The future appears uncertain and gloomy
against the backdrop of an unprecedented slowdown in economic activity,
employment and export earnings. Risks to our growth prospects are
slanted to the downside. The dark shadow of stagflation looms over us
and our outlook.
The Indian Experience
In India, we have adopted an inflation targeting framework since 2016,
with a target of 4 per cent defined in terms of headline CPI inflation within
a tolerance band of +/- 2 per cent around it. Policy decisions are taken by
a majority vote by a monetary policy committee (MPC). There are strong
accountability criteria embedded into the framework by legislation and
associated regulations in the case of deviations of inflation outcomes from
the target. While inflation averaged under 4 per cent during 2016-20, it
rose to 6.2 per cent in 2020-21 - the year of the pandemic's first wave.
Although it moderated in the following year, i.e., 2021-22 to 5.5 per cent
and was projected to ease further to 4.5 per cent in 2022-23 as recently
as February 2022, the war in Ukraine has altered the outlook drastically.
Although it appears to be moderating from its peak of 7.8 per cent in April
this year, we would prefer to await more incoming data before we are
convinced that this a durable trend. While some easing of international
commodity prices and supply chain pressures, both globally and
domestically, are positive developments, upside risks remain in the form
of potential second order effects and the transmission of input cost
pressures to the sticky core component of inflation. For the financial year
2022-23 (April-March) as a whole, the RBI has projected that headline CPI
inflation would average 6.7 per cent.
Accordingly, the RBI has embarked on a front-loaded monetary policy
response, with a cumulative 140 basis points increase in the policy rate
so far, besides narrowing of the policy rate corridor in April that pulled up
money market rates by 40 basis points from pandemic lows. In its latest
meeting in early August, the monetary policy committee (MPC) decided to
remain focused on withdrawal of accommodation to ensure that inflation
remains within the target going forward, while supporting growth.
Simultaneously, the RBI is engaged in withdrawal of the liquidity infused
into the economy during the pandemic in a calibrated, multi-year time
frame.
As the inflation forecast performs the role of an intermediate target in the
monetary policy framework, the RBI has taken several initiatives to
strengthen inflation monitoring and improve the accuracy of forecasting.
Besides widening the ambit and depth of a suite of forward-looking
surveys, a data science lab has been set up to explore alternative
forecasting techniques and models, including artificial intelligence and
machine learning (AI/ML). In view of the sizable share of food in the
consumer price index and the fact that the Indian economy is prone to
supply shocks, work on assessing the crop situation through remote
sensing has also been started in the data science lab to assist inflation
forecasting. In addition, new initiatives are being taken to gauge the
public's expectations through sentiment analysis that should inform the
forecasting exercise and thereby improve precision. We have also
stepped up the gathering of market-based intelligence from trade bodies,
traders, domain experts and regional units. The intent is to assimilate as
much useful information as possible and enrich our understanding of
inflation dynamics. In the near-term, however, the inflation trajectory
continues to be heavily contingent upon the evolving geopolitical
developments, international commodity market dynamics and global
financial market developments.
Concluding Remarks
As central banks and public institutions, we are entrusted with ensuring
and maintaining macroeconomic and financial stability and ensuring the
progress of our economies to secure the full actualisation of our
developmental aspirations. We face challenging trade-offs in our day-to-
day functioning and keen public scrutiny. Mostly unsung, our role has
undergone a transformation in recent years. From lenders of the last
resort, we have become defenders of the first resort. Hence, our response
to inflation shocks such as the one we face today has to be predicated on
managing expectations and fortifying credibility. If credibility is high and
the shock is transitory, inflation returns to equilibrium without the need for
any monetary policy action. On the other hand, repeated supply shocks -
which we are encountering now - trigger second round effects through
cost pushes, expectations, exchange rate and demand channels,
warranting pre-emptive monetary policy action. Even with perfect
credibility, monetary policy cannot look through the second-round effects
of repeated supply shocks. If the inflation target is breached for a
prolonged period, this could unsettle expectations and eventually get
reflected in higher inflation. Higher credibility can reduce - not substitute
for - the monetary policy response to second round effects of repeated
supply shocks. At the current juncture, our experience is that by
frontloading monetary policy actions, credibility is demonstrated by
showing commitment to the inflation target. Another dimension of
monetary policy credibility is the timing of its response. A delay in the
monetary policy response leads to a further loss of credibility, unhinging
of inflation expectations and eventually, higher inflation outcomes with a
higher sacrifice of growth.
SAARC has great potential for economic expansion with abundant natural
resources, human capital and market access. The promotion of economic
and social development through increased trade and investment and
through deeper regional economic integration holds considerable promise
in South Asia. We must rise up to this challenge and seize the window of
opportunity even as we recover from the debilitating effects of the
pandemic and geopolitical developments. High quality research and
engagements in seminars such as this one will help us build capacity and
technical skills, illuminating our way forward. The Roadmap of Regional
Cooperation which was framed in 2016 needs to be revised to reflect the
current realities and focus areas, with quantifiable milestones and
timelines within the mandate of SAARCFINANCE.
I wish you all success in your deliberations.
Thank you.