India's Chief Economic Advisor expects inflation fears to ease over time

The sentiment of markets reacting to a possibility in advance and that spiralling into a continuous cycle was echoed by Federal Reserve Chair Jerome Powell in his speech at the Jackson Hole symposium on August 26:

They are the rate at which consumers, businesses, and investors expect prices to rise in the future. If prices are expected to rise 3 percent, businesses will look to raise prices by at least 3 percent, while workers will expect a similar quantum of bump up in their pay.

Between 1978-82, the US underwent its second stint of double-digit inflation in less than a decade, prompting then Fed Chair Paul Volcker to raise interest rates to as high as 19 percent. Volcker engineered two massive but brief recessions, and the subsequent cut in spending managed to cool down inflation.

The US is currently experiencing its worst inflation in four decades, prompting the FOMC to hike interest rates for four consecutive times. Experts now predict another 75 basis points hike in the September meeting and another 50 basis points in November. Inflation data for August in the US will be released this evening.

Higher interest rates have always meant capital outflows from emerging economies like India. But the CEA is not worried about the Federal Reserve and the quantum of their rate hikes.

"Even if the Federal Reserve continues to tighten, the market will see through that in the next year. Developed economies will probably have an economic slowdown, which will lead to a reversal of monetary policy, and capital flows will therefore move towards regions which offer them the higher returns, and India is one of them," he said.

The CEA also spoke about the currency, saying that India is not defending its currency, but the fundamentals of the country are such that the rupee can take care of itself.

"The RBI is making sure that whatever direction the rupee is moving in-line with market trends is gradual and does not impose a burden on importers or exporters," he said.

The rupee is down 6 percent this year against the US Dollar, even hitting an all-time low of 80.23 in August. Despite that, it is the fourth-best performing currency among Asian peers, after the Indonesian Rupiah, Singapore Dollar, and the Hong Kong Dollar.