Second-Round Effects Of War Real Concern, RBI In Wait-and-Watch Mode: Governor Sanjay Malhotra

Second-round effects of the supply shock due to the West Asian war are the real concern, said Reserve Bank of India Governor Sanjay Malhotra during his speech at Princeton University, his alma mater.

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Malhotra said that the real challenge of monetary policy is to limit the first-round effects of the war so that it does not result in second-round effects on the economy.

Second-round effects are the indirect but persistent consequences of a crisis. “The appropriate monetary policy response to such a supply shock is to look through the first-round effect to the extent that it does not feed into second-round dynamics,” the governor said during his speech.

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He highlighted the importance of the Gulf region to India by pointing out that West Asia contributes about one-sixth of India’s exports, one-fifth of imports, and half of the country’s crude oil import supply.

The war also has the potential to impact the agricultural output of the country, as India is dependent on the Gulf for two-fifths of its fertiliser imports.

Also, almost two-fifths of India’s inward remittances come from the West Asian region.

“Second-round effects are the real concern. They can materialise if supply chain disruptions continue for long. Then, what began as a supply shock can become embedded in the general price level,” Malhotra said, warning about the long-term impact of the war in terms of inflation.

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“Preventing this entrenchment is where monetary policy has a primary role to play—through its influence on inflation expectations rather than through blunt demand compression,” he said.

The heightened uncertainty and volatility due to the war is the reason that the banking regulator’s monetary policy has been agile and nimble instead of making firm commitments on the future path of policy, he explained.

The governor said that the RBI is in a wait-and-watch mode now to swiftly respond to changes on the geopolitical front.

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