Inflation vs GDP Growth: India, China, USA and UK chart their different paths

While it is considered almost impossible to manage both inflation and economic growth as one likes, such as maintaining low inflation in a high economic growth scenario, policymakers and central banks always try to strike a delicate balance between inflation and economic growth.

New Delhi:A coordinated approach against runaway inflation in emerging and developed economies has given way to country specific measures as central banks of India, USA, UK, and China are following different paths as per peculiar conditions of growth versus inflation matrix in their countries.

While it is considered almost impossible to manage both inflation and economic growth as one likes, such as maintaining low inflation in a high economic growth scenario, policymakers and central banks always try to strike a delicate balance between inflation and economic growth.

For example, the US Federal Reserve, which is the banking sector regulator in the country on the lines of the Reserve Bank of India, has been raising policy rates since April last year to battle sky-high inflation in the USA which was at a record level in the last four decades. In India, the Reserve Bank also followed in the footsteps of the US Federal Reserve by increasing policy rates, known as repo and reverse repo rates to fight high retail inflation.

Under section 45ZA of the RBI Act, the Bank is required to keep the retail inflation within the target band set by the Central Government; else it would have to explain the reasons for its failure in keeping the retail prices under check to the Government.

While the US Federal Reserve increased policy rates from near zero in April 2022 to a record 5-to-5.25 percent range in 2023 as it struggled to contain the retail inflation in the world’s largest economy which has been hovering close to 5 percent, the RBI in India followed a coordinated path but eventually diverged from the strategy to follow a policy rate strategy that is more suitable to the country’s specific needs.

India earlier followed coordinated rate hikes

In India, the Reserve Bank started raising rates from May 2022 as it called for an unscheduled meeting to increase the policy rates as the retail inflation, measured as the Consumer Price Index (CPI) in the country was hovering high due to a variety of reasons, including the high crude and commodity prices triggered by supply chain disruptions and Russia-Ukraine war.

The Reserve Bank continued to follow in the footsteps of the US Federal Reserve despite some Indian economists calling the coordinated rate hike policy not suitable to India beyond a point. But the RBI hiked the benchmark interest rate, the Repo Rate, by 250 basis points (2.5%) since May 2022.

The data suggests that due to the coordinated monetary policy actions witnessed between April 2022 and February 2023, the gap between US Fed Funds Rate and India’s Repo Rates, has now declined to less than 2 per cent.

However, as a high-interest rate regime coupled with tight money supply policy, started to impinge on the growth rate, the Reserve Bank eventually signaled a departure from the coordinated rate hike policy followed by the Central Banks in the USA and England. The RBI had not hiked policy rates in the last two monetary policy meetings held in February and April this year.

What is happening in the UK and USA?

Unlike India, the world's largest economy, the USA and, also the United Kingdom, continued to reel under the pressure of runaway inflation which has unsettled the budget of a large part of their population.

In a latest move, the Bank of England (BoE) hiked the policy rate by 50 basis points to 5 percent last week, citing a high inflation which is 9 percent as against the BoE’s target of 2 percent.

The policy rates set by the Bank of England is similar to the current policy rates in the USA that is in the range of 5-to-5.25% as US Federal Reserve did not raise the rates in the FOMC meeting held last week. A departure from 10 straight rate hikes effected over the last one year.

While the first rate hike effected by the US Fed Reserve in the current cycle was in March 2022 when it hiked the Federal Funds rate by 25 basis points (quarter of a percent), lifting the Funds Rates from near zero to 0.25 to 0.5%. It brought the US Policy Rates from near zero in March 2022 to 3.75-4% in less than 8 months, eventually to 5-to-5.25% at present.

US Federal Reserve Chair Gerome Powell said maintaining inflation at 2% was vital for the health of the US economy. Some US economists are not ruling out two more hikes by the US Federal Reserve in the current calendar year.

What is happening in China, East Asian countries?

Unlike the developed economies such as the USA and European countries that are battling inflation, emerging economies such as India, Indonesia and China in Asia are battling high inflation and low growth simultaneously and their policy makers and central banks have to follow a tailor-made monetary policy suitable to their country’s specific needs.

For example, People’s Bank of China (PBoC) has started to lower the interest rate as the Chinese economy is witnessing a slowdown despite lifting of Covid restrictions since the start of this year. In a surprise move, People’s Bank of China cut the 7-day reverse repo rate by 10 basis points on June 13, a first rate cut in 10 months.

It followed the 10 basis point cut by another 10 basis point on June 15 as the first rate cut was not considered enough to boost the business sentiment. However, China’s Central Bank did not stop at the two cuts in policy rates announced in the second week of June but in order to support the economic recovery, it also reduced its one-year loan prime rate (LPR) by 10 basis points from 3.65% to 3.55%, and reduced the five-year rate by the same margin to 4.2% on June 20.

Similarly, Indonesia, an important member in ASEAN, has been grappling with the issue for quite some time and its central bank is also expected to deliver a first rate cut by the end of this year.