Central Banking System: Survival in a Global Fallout
The central banks around the world had already been tackling the herculean task of reviving economies from the post Covid shock. However, their capacity to take action was further bound by the recent geopolitical fallout. The invasion of Ukraine by Russia has pushed the global prices, which were already climbing due to supply shocks, even higher. This chain of events has spurred the central banks around the world to take quick yet careful steps - an evident observation that can be noticed as the central bank of America raises its target interest rate for the first time in four years. The policymakers are in a sheer dilemma as they struggle to balance price with growth imperatives.
The United States of America and its allies have already decided to exclude major Russian banks from the SWIFT platform, which offers a globally accepted mechanism for smooth electronic monetary transfer among various banks. The West’s coordinated financial weaponry has inarguably opened a new age of Economic war. Anticipating a complete alienation of Russia from the rest of the world’s banking system, the Reserve Bank of India has advised the different banks based and operating in the subcontinent to explore an alternative mechanism for trade payments.
It is important to note that as of the financial year 2021-22, Indian exports to Russia amounted up to USD 2.6 billion whereas the imports from Russia (to India) were worth USD 5.4 billion. Moreover, the Indian Oil Corporation has already purchased around three million barrels of crude oil from Russia at a hefty discount which will be delivered in May. Such burgeoning trade relations are being cited as the reason behind India’s decision to abstain from denouncing the Russian invasion of Ukraine.
With the United States of America continually putting fresh sanctions on the Russian central bank, the VTB bank, the Reserve Bank of India, wants to protect and prevent local lenders from adverse eventualities. Thus, the RBI has been holding constant consultation sessions with the union government as well as the state-owned banks to come up with a rupee-rouble exchange arrangement that would enable smooth payments and exports to continue non controversially.
Even as the consumer price inflation has remained above the upper end of the target band of 2- 4 per cent for more than a year now, the Reserve bank of India has left the policy rate unchanged at 4 per cent, with it choosing to maintain an accommodative stance until it sees signs of a durable recovery and growth. Some analysts, however, expect the regulatory bank to hike the reverse repo rate by as much as 40 bps before starting to raise the repo rate from April due to the sudden geopolitical and economic fallout.
Such moves had been anticipated not only due to the Russia-Ukraine conflict but also to mend the post Covid damages in the economic machinery. Moreover, the covid induced supply crunch and the economic setback caused by the Taliban’s occupation of Afghanistan was also a notable geopolitical event that impacted the central banks and rushed the process of policymaking albeit with some well-thought amendments. Diplomatic and economic relations are very fragile and must be handled with care and the burden of maintaining those relationships often falls on no one else but the central banks of the countries.
Global prices rose by 7.9% in February compared to the last year. Many suspected that they would begin to fall as Covid induced supply chain bans were eased. But the war in Ukraine slashed those hopes. The surge in the prices of crude oil and other commodities that resulted from Russia’s invasion of Ukraine will put additional upper pressure on short-term global inflation. Apart from the central banks of India and America, the National bank of England announced recently that it would raise its key interest rate.
Last year, the central banks had to deal with the pandemic which led to the highest inflation in four decades. And now, they have to think through the consequences of war, the results of which are unpredictably inflationary or recessionary. The war increases the possibility of a situation where the rate of growth declines while the already high inflation gets even higher. The primary reason behind such an occurrence is the shock to the global commodity market, where prices have elevated quite dramatically. This further leads to a rise in the cost of production, cost of labor, cost of living which further fuels inflation.
To control such an inflationary spiral and keep prices in check, the central banks often raise interest rates which leads to the loans becoming expensive. As a result, people try to spend less, and liquidity is soaked from the market. When people spend less, the aggregate demand falls; as a response to this, the supply has to be reduced. This further adjusts common prices to a lower level which helps cure inflation. Currently, the same seemingly basic but functionally complex strategy is being exercised and implemented throughout the globe by the central banks.
By Kratika Goswami