An economic storm 

The Covid pandemic’s sudden and severe outbreak gave very little time to both monetary and fiscal authorities to deliberate on the appropriate doses and combination of two sets of public policies. Both monetary and fiscal policies were ultra-accommodative to deal with the catastrophe.

Besides fiscal deficit, the balance sheet size of the US Fed alone went up from less than $4 trillion to nearly $9 trillion during the pandemic. The policy profligacy on most parts of the world arrested the contraction of GDP, but asset/commodity prices quickly flared up globally.

As against the target of about 2 per cent, retail inflation in most developed countries is currently approaching double-digit. Central banks were behind the curve for a while as they misread the current inflation as transitory. Although originated from severe supply disruptions following the pandemic, retail inflation has been generalised, at least partly due to policy excesses and post-pandemic revival of demand. Despite low-capacity utilisation, supply response has been generally inadequate. The demand-supply mismatch has widened as the post-pandemic recovery has faltered.

The public policy responses to high inflation and low growth are difficult. Nevertheless, most developed countries’ central banks have realised that inflation control is a must, even at the cost of growth, to prevent macroeconomic imbalances from aggravating further.

Recession fears

The probability of recession, at least in developed countries, has been accentuated due to the rapid reversal of monetary policy. Can they really sail through the choppy growth scenario ahead and return to a positive real policy rate? Can they achieve price stability if they abort early as pressure to support growth would emerge sooner than later?

The prolonged Russian-Ukraine war added a new dimension to supply disruption. Globally, commodity prices, especially crude oil and gas prices have been ruling high despite the global growth slowdown. Monetary policy in most emerging market economies (EMEs) is also in tightening mode due to inflationary pressures. Is it due to the second-round effect, inadequate supply response vis-à-vis sustained demand or imported inflation due to high crude oil prices?

The US monetary policy has unnerved the rest of the world. The global meltdown of asset prices following successive large Fed rate hikes has begun. Despite the US GDP contraction during the first two quarters of 2022, capital has been flowing unidirectionally toward the US due to the dollar’s appreciation.

Trying to sail cautiously in the periphery, the EMEs are facing headwinds on multiple fronts - currency depreciation, capital outflows, export slowdown, imported inflation and above all growth slowdowns.

Among EMEs, India may escape the current global storm with less damage to its economy. India did not go for fiscal excesses during the pandemic. Cash outgo from the Budget was need-based to help the most vulnerable sections of society, combined with several structural reforms to make the economy resilient and self-sufficient. The repo rate was retained well above its peers, which helped RBI to hike the repo rate not more than 50 basis points at a time, compared to 75 bps by the Fed Reserve consecutively three times so far in 2022.

The excess liquidity has been almost clawed back mainly through forex market interventions. The rupee’s depreciation against the dollar is much less compared to many currencies.

As the fastest-growing major economy, India would continue to attract global investment notwithstanding uncertainty about portfolio flows. India’s external debt-to-GDP at 20 per cent is modest; hence, there is no cause for concern in servicing external debt despite rising global interest rates.

The writer is currently RBI Chair Professor, Utkal University, and former Head of the Monetary Policy Department, RBI

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