By Dr. Nilanjan Banik
Prices convey vital information. The price of a good reflects its scarcity, while interest rates—the price of money—influence whether households and firms spend, save, or invest. When governments alter these signals to pursue broader policy objectives, the consequences can extend well beyond the original target.
Two developments in 2026 illustrate this problem. India’s strong GDP growth has not always been matched by stock-market performance. One explanation may be the country’s high cost of capital. The benchmark 10-year government bond yield is close to 7%, while a conventional rule linking long-term yields to nominal GDP growth would suggest a rate nearer 11%, based on real growth of around 7% and inflation of approximately 4%.
This difference matters because government bond yields provide a benchmark for pricing other assets. If this benchmark is held artificially low, investors may accept lower returns on riskier assets, encouraging leverage, speculation, and asset-price inflation. Several developments are consistent with this possibility: margin funding has reportedly doubled over three years, valuations of non-large-cap stocks remain elevated, retail investors have moved into riskier assets, portfolio outflows have increased, and the rupee has depreciated. This is an important lesson for the Reserve Bank of India’s Monetary Policy Committee as it met on October 5 to 7.
Fiscal pressures help explain the preference for low interest rates. Interest payments reportedly account for nearly 80% of India’s new borrowing. A substantial increase in rates would therefore worsen the government’s fiscal position. The decision to address pressure on foreign-exchange reserves through a special foreign-currency deposit scheme, rather than relying mainly on higher domestic rates, reflects this reluctance to adjust the policy rate directly.
China’s influence on U.S. inflation has changed significantly since the late 1990s. Before China joined the World Trade Organization in December 2001, its access to the U.S. market faced annual congressional review. This uncertainty discouraged American firms from establishing deep, long-term supply chains centred on China.
WTO accession provided more permanent market access and encouraged investment in China-linked supply chains. For nearly two decades, low-cost Chinese goods helped keep U.S. core goods prices broadly stable or declining, even during periods of strong economic growth and low unemployment. The resulting “China price” weakened the traditional relationship between tight labour markets and rising inflation.
The COVID-19 pandemic reversed this pattern. Factory closures, shipping bottlenecks, and supply shortages transformed China from a source of cheap goods into a source of scarcity and higher costs. Alongside fiscal stimulus and energy shocks, these disruptions contributed to the inflation surge of 2021–2022.
Tariffs introduced since 2025 created another price shock. Tariffs imposed through late 2025 increased the core goods Personal Consumption Expenditures price index by approximately 3.1% through February 2026. By mid-2026, prices of goods imported from China had risen 0.9% in a single month—the sharpest monthly increase since early 2008—and were 1.3% higher than a year earlier.
The situation changed after the U.S. Supreme Court struck down tariffs imposed under emergency economic powers in February 2026. Effective tariff rates fell from a peak of 11% in late 2025 to just below 7% by May. Tariff pass-through into consumer prices subsequently stabilised, while other factors, including conflicts and supply disruptions in the Middle East, increasingly explained above-target inflation.
China’s direct contribution should nevertheless be kept in perspective. Chinese imports account for only about 2% of goods in the U.S. Consumer Price Index basket and 2.7% of the PCE index. Tariffs have also redirected trade, with some Chinese goods moving to Europe. The European Central Bank estimated that this could reduce euro-area inflation by 0.15 percentage points in 2026. Tariffs may therefore relocate price pressures internationally rather than eliminate them.
In the United States, tariffs have raised the price of imported goods, particularly those from China. In India, interest rates that may be below levels suggested by economic fundamentals could be distorting the price of capital. Although these cases differ, both show the consequences of weakening market-based price discovery. (IPA Service)
(The author is Head, Economic Policy Centre, Mahindra University).
