Why in the News?

The Asian Development Bank recently issued a cautionary note for India’s susceptibility to imported inflation due to potential rupee depreciation amidst escalating interest rates in the West.

What is Imported Inflation?

• Imported inflation refers to the increase in the prices of goods and services within a country caused by a rise in the cost or price of imports.
• This phenomenon occurs when factors such as a depreciating currency, higher import costs, or increased international prices lead to elevated expenses for imported goods and services.
• Consequently, producers may adjust their prices upward to offset these higher costs, resulting in inflationary pressures within the domestic economy.
• This idea connects with the theory of cost-push inflation, which means that when input costs go up, it can cause prices for final products to go up too.

Reason behind the imported inflation:

• Capital Flows: Increased interest rates in Western economies attract foreign investors seeking higher returns, leading to capital outflows from countries like India and potentially depreciating the Indian rupee.
  • When a currency depreciates, local consumers require more of their domestic currency to procure foreign goods, consequently elevating import prices.
• Borrowing Costs: Indian businesses and the government may face higher borrowing costs for infrastructure projects and investments if they raise funds in foreign currency-denominated international markets.
• Inflationary Pressures: Capital outflows can pressure the Indian rupee, causing imported inflation as the cost of imported goods rises due to currency depreciation.
• Trade Competitiveness: Exchange rate fluctuations from Western interest rate changes affect India’s trade competitiveness, impacting exports, imports, and domestic consumption.

Back2Basics: Asian Development Bank (ADB)

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