Keeping an eagle eye on two ‘I’s will be imperative – Inflation and INR

The RBI governor expressed confidence in India’s resilience during the monetary policy committee statement in October. Comparative analysis suggests that India has done well in several economic parameters relative to Advanced Economies (AEs) and a few Emerging Economies (EEs). However, its economic performance must improve relative to the peer EEs with whom the country is competing for investment.

A key differentiator would be the course India takes in charting inflation and the INR currency (the two I’s) trajectories over the next year. We believe that inflation is expected to be a menace for longer, due to relatively higher oil prices, a stronger US dollar (USD), and supply chain interruptions in certain industries. Further, a stronger economic recovery may add to the overall pressure.

As we examine the curious case of INR currency, we expect the domestic currency trajectory to reverse with an improved domestic demand outlook and stronger capital flows. The USD index may also retreat, as seen in the past. However, gains may be offset by a weaker current account. In the face of a global slowdown (implying slow export growth), could the possible solutions be reducing India’s import dependence on non-essentials, looking for alternative import destinations, or increasing trade in its own currency?