IMF Managing Director Kristalina Georgieva summed up the current state of the global economy well in a speech this week. She said, “To put it simply, the global economy is being pulled in two opposite directions: a negative energy supply shock and a positive demand shock from AI.” That explains why, as Martin Wolf writes in his FT column: “The disruption to oil supply, oil prices and the world economy more broadly has, in truth, been quite surprisingly manageable”.
Will the resilience last? Georgieva said that “will depend on our success in navigating three major crosscurrents: the rapid arrival of AI, persistently high energy prices, and record levels of public debt”. What’s common among these three factors is that they all stoke inflation. Georgieva pointed out: “The AI building boom is inflationary. The energy and food shocks are inflationary. Tariffs, defence spending, and high public debt can be inflationary.” Her policy prescription is to rein in fiscal deficits while she also adds that “now may be a good time for a prudently hawkish bias in many countries’ monetary policy”.
Is the RBI’s 25 basis point rate hike and shift in stance to ‘calibrated tightening’ evidence of a prudently hawkish bias? Well, if we take the RBI’s survey of professional forecasters’ estimates, they see retail inflation at 4.7 percent by Q2 FY2028, or about a year ahead. The current repo rate of 5.5 percent, therefore, gives a real rate of around 0.8 percent. That’s not very tight, which is why analysts are saying there could be multiple hikes ahead and the RBI has also said it will do what it takes to reduce liquidity so that the rate increase is passed on. The trouble with a “calibrated” tightening cycle is that inflation may not agree to move in calibrated increments.
Indeed, two technical studies in the RBI’s Monetary Policy Report made the point that the forces that kept inflation low have dissipated while inflation is getting broad-based and household inflationary expectations have risen for the sixth straight survey round. This column argues that the RBI’s stance signals caution, not aggressive tightening, and that investors could buy bonds as the market has already priced in the adjustment. We considered whether the RBI’s change of stance would dent the fragile sentiment in Indian equity markets.
Incidentally, RBI’s latest consumer surveys show declining optimism about the future, but also higher spending, very likely on the back of increased borrowing. That is true also of markets, which too show high levels of leverage, with hedge funds on a borrowing spree on Wall Street -- They could well be a systemic risk. In the Indian markets, stockbrokers’ profits may increasingly come from loans and this column warns that Indian regulators need to learn from the LTCM crisis. Those who forget history are condemned to receive margin calls.