By Megha Jain & Hrishikesh Desai
The global economic environment has rapidly grown in complexity since the onset of the COVID-19 pandemic. The Russian Federationthe invasion of Ukraine has exacerbated this complexity through its ripple effects on supply chains, commodity markets, inflation, energy markets and broader macroeconomic growth prospects. Even central bankers and prominent economists are not able to accurately read current economic trends. Recently, the president of United States Federal Reserve, Jerome Powell, acknowledged that the Fed had gotten inflation wrong, and they thought it was just “transitional.” Even prominent economist and US Treasury Secretary Janet Yellen admitted that her economic forecasts were wrong, saying, “I was wrong then about the path inflation would take.
It is no leap to suggest that the mindsets and priorities of policymakers and experts are fundamentally changing due to the unprecedented disruptions to people’s lives, global trade and the global economy.
Emerging market economies like India are hardest hit due to significant rise in agricultural commodity prices, rising food insecurity, slowing growth, soaring borrowing costs and the increase in extreme poverty in vulnerable population groups, leading to increased income and wealth inequalities.
We see financial and other news outlets making one or more of the following predictions for what is to come:
- It will be a repeat of the global financial crisis of 2008.
- It’s the calm before the storm, which is another Great Depression of 1929.
- It will be a mild to severe recession caused by rising interest rates which will weigh on growth.
- It is characteristic of a period of stagflation due to a combination of events leading to high prices, low growth and high unemployment.
- Tech and real estate bubbles are starting to burst.
- Inflation is no longer just “transitory” and will persist for some time.
- This is all just transitory and we will see a longer term recovery.
Let us examine the significance of each of the above-mentioned macroeconomic challenges affecting developing countries like India and unpack the magnitude of their impact on India’s economic future.
The COVID-19 pandemic which started in December 2019 has spared no sphere of the Indian economy. Severe and continued lockdowns in China and the Russian-Ukrainian war have affected global energy, food and mineral supply chains, and pent-up demand for goods and services fueled by pent-up economies in post-pandemic economies without lockdowns (like India) has caused significant inflationary conditions. Additionally, recent heat waves in India have compounded the inflation problem by pushing up agricultural commodity prices and reducing agricultural production (particularly wheat).
Inflation is rightly referred to as a double-edged sword as it forces central banks to raise interest rates, which results in lower borrowing and lower business spending and investment. However, lower spending leads to lower demand and lower job growth which in turn halts overall economic growth. The latest inflation data for India suggests that India’s retail inflation is around 7.03% and wholesale inflation is around 15.50% which is well above the Reserve Bank of India (RBI) tolerance thresholds. The RBI has raised interest rates by 90 basis points so far in 2022, and Governor Shaktikanta Das has signaled further potential rate hikes.
The Crude Oil Conundrum
High crude oil prices have always been the bane of India’s economy and have led to higher prices for petrol, diesel and liquefied petroleum gas (LPG), causing headline inflation to soar .
Goldman Sachs has indicated that Brent prices could rise as high as $175 a barrel if Russian crude oil exports fall due to sanctions. Other measures such as an increase in OPEC production or the release of more emergency oil stocks would fail to address the supply shortfall. This is bad news for India’s post-pandemic economic recovery. India’s projected sustainable economic growth takes place when Brent crude prices hover around $70 per barrel. The only option for the Indian government is to lower fuel taxes and absorb some of this shock.
However, such a measure would reduce tax revenue and worsen the fiscal (budget) deficit. Additionally, India relies heavily on liquefied natural gas (LNG) to produce fertilizer, and an oil shock of this magnitude would send its fertilizer subsidy bill skyrocketing.
High crude oil prices are also negatively affecting India’s balance of payments and causing its current account deficit to explode. India imports more than 80% of the oil it needs. Much of this demand is inelastic in nature, and India’s moves towards renewable energy, local oil exploration and its ethanol-gasoline blending strategy will not be of much help in solving this problem in the short term. term. A saving grace for India could be a slowdown in China’s economy that puts renewed upward pressure on oil prices due to reduced demand.
Exits of Foreign Institutional Investors (FII)
Rising global economic uncertainty continues to result in aggressive selling by foreign investors due to increased perceived risk in developing economies. This is already happening in India, with Societe Generale reporting that so far in 2022, FII outflows from India have reached record highs. This put downward pressure on the Indian Rupee (INR), which rose to record highs against the US Dollar (USD). A weak rupee increases the cost of imports for India and lowers its foreign exchange reserves.
A weak currency is helpful if a country has a strong export base because it makes its exports more attractive to foreign buyers. However, India faces a catch-22 situation as its imports of crude oil and commodities are growing at a much faster rate than its exports. Moreover, its major export industries such as petroleum products, pharmaceuticals, automobiles, and jewelry are highly dependent on imported items, which increases the cost for Indian exporters. Furthermore, many Indian exports (e.g. textiles and agricultural products) are price elastic, meaning that higher production costs cannot be passed on to overseas consumers without reducing export demand. .
The black swan theory
The black swan theory suggests that highly improbable and aberrant events (black swan) can invalidate all previous general beliefs and knowledge about something that arises from more probable and routine events (white swan). These low predictability, high impact events are often overlooked and cannot be predicted, but they have the most significant influence in shaping the world as we know it. We believe we are witnessing a black swan paradox in India – a few significant black swan events (e.g. COVID-19 pandemic, Russian-Ukrainian war) that were not reasonably conceivable significantly influence all aspects of the Indian economy in relation to the routine and predictable white swan events, the impact of which most experts predict and explain.
Most expert analysis of Black Swan events is “after the fact” (after they happened), which doesn’t really help in planning them. Furthermore, most economics and political scientists also fail to assign the correct probability of occurrence to these events. Developing countries like India need to implement highly tailored and targeted fiscal and monetary policy measures, as well as a complete overhaul of their trade policies. Traditional economic remedies such as liquidity injections, interest rate hikes, central bank interventions in the currency market and other “one size fits all” policies are not feasible to handle such swan events. black.
A better approach for developing countries like India is to focus on strengthening and reviving their flagship export sectors and pushing for structural changes in the economy to absorb shocks. of the black swan through technological innovations, efficient management of capital, labor and natural resources, and maintaining a progressive political landscape.
(Megha Jain is assistant professor at Daulat Ram College, University of Delhi, and Hrishikesh Desai teaches at Arkansas State University, USA; opinions are personal.)