While the Indian economy continues to demonstrate robust performance, the global monetary conditions present a potential risk to India in the near future. We live in a fairly tentative global environment and it would take some sustained and careful management by central banks across the world to ensure the global recovery is sustainable. Considering this background, RBI is rightly focused on managing inflows and inflationary conditions.
The policy decision of RBI to increase interest rates in India clearly demonstrates the multi-speed world we are living in, where many countries are focused on reviving the underlying demand through quantitative easing with near-zero level interest rates, while we are tightening the monetary flow to manage growth and inflation. This is a mega trend that is expected to continue for some time to come. While this is a happy situation to be in, we have to be careful not to push our cost of capital in a manner that will render our assets uncompetitive globally in the long run.
The US Fed is expected to unleash a wave of liquidity into the system and a significant portion is likely to flow into emerging markets like India. With a volatile currency situation globally and benign interest rates, it is critical for India to manage the flows in a proactive manner to channel the inflows to create productive assets for the country rather than let liquidity flow into speculative asset markets.