India needs to remain defensive in monetary, fiscal response to global tightening: Douglas W Diamond

Cautioning Indian policy makers to remain defensive in their monetary and fiscal response to the global tightening, Nobel Laureate in Economics Douglas W Diamond has said India’s inflation rate is better in comparison with the rest of world. He also pointed out that India needs to respond to the global monetary tightening in an “appropriate way” ensuring that the economic activity does not slow down.

In a recent interview with Fortune India, Diamond, who won this year’s Nobel Memorial Prize in Economics said, “Inflation in India is in reasonably good shape right now, compared to the rest of the world. You're a rapidly growing economy. Things are economically doing quite well in India right now.”

Diamond pointed out that India needs to be defensive while responding to the changes in monetary and fiscal policies of the U.S. and the rest of the world. “Responding to the U.S. in an appropriate way, and making sure that India doesn't have a huge slow down in business lending, and a huge cut back in household lending is important,” Douglas said. 

Stressing that the Federal Reserve and other central banks around the world also need to be cautious regarding the pace of tightening of interest rates, diamond said spike in interest rates hurts short-term debt financed firms, institutions and insurance companies. 

“I've been up with the view that the Federal Reserve and other Central banks around the world have to be a bit careful to make sure that their pace of tightening. Because if you do the tightening too fast, there will be a spike in interest rates and the spike in interest rates hurts all the short term debt financed firms, institutions, and insurance companies,” Diamond said. 

Diamond’s view comes at a time when both U.S. Fed and RBI have reduced the pace of interest rate hike but at the same time remained hawkish in their outlook. In its last meeting in December, the Federal Reserve raised the key interest rates to the highest levels in 15 years, by 50 basis points (bps), while keeping it to the targeted range between 4.25% and 4.5%. It expects to keep the interest rates higher through next year.

Meanwhile, in India, the Reserve Bank of India in its last monetary policy committee meeting in December hiked the key repo rate by 35 basis points to 6.25% as inflation showed signs of inflation. With the latest rate hike, the repo rate has been hiked by 225 basis points this year. The apex bank hiked the repo rate by 40 basis points in an off-cycle meeting in May and by 50 basis points thrice since June this year. 

India’s retail inflation, meanwhile, eased to an 11-month low of 5.88% in November 2022, marking a fall below 6% for the first time this year owing to an ease in food prices. The country’s central bank, the Reserve Bank of India has kept the inflation target for the fiscal year unchanged at 6.7% while cautioning the battle against inflation is yet not over.