The Reserve Bank of India fears that rising current account deficit in the United States could adversely impact interest rates and inflation globally and India could not be an exception.
With little room to manoeuvre on fiscal policy (in the US), the dollar decline may require monetary tightening, leading to rise in interest rates and "this will have serious implication for the sustainability of growth not only in the US but in several developing countries (including India)," RBI Deputy Governor Rakesh Mohan cautioned.
Coming as it does ahead of the slack season Monetary and Credit Policy, RBI has sounded alarm bells apparently on the possibility of hardening interest rates and rise in inflation in the country.
"If the new globalised economy means that exchange rate adjustments as a means of correction of imbalances have become less potent, then the swing in exchange rates to correct emerging imbalances will have to be much larger than before, bringing in their wake instability eventually," he said in the latest RBI bulletin.
"As these exchange rate adjustments in the world's major currencies take place, and inflation and interest rate do rise, they will bring in their wake economic debris in different places," he said.
Observing that there has "not been adverse impact" of the dollar's decline on the US so far, Mohan said inflation is still low due to slack in that economy and interest rates are at historically low levels and "depreciation of the dollar eventually is expected to feed through inflation."
The international economy continues to face the risk of persistent US external imbalances which are reflected in the external imbalances in several Asian countries, Mohan said.
The US current account deficit of 5.1 per cent of GDP is mainly the manifestation of its large savings-investment gap, which widened to a high level of 5.3 per cent in 2003, he said.
He said past experience suggests that the correction of such a high order of external imbalances could be associated with high inflation, rise in interest rates and output fall.
However, he highlighted, "We in India have followed a relatively flexible exchange rate policy to ensure smooth adjustment along with corrections in the world economy."
He said there should be more vigilance on the new risks that could be generated in the process of correcting the current macroeconomic imbalances.
