Home / Economy / Five charts tell why uncertainty is the big theme of 2022

For the global economy, the common refrain of 2022 is “rising uncertainty". It’s keeping everyone from businesses to central banks on their toes. The challenges are many and varied: geopolitical tensions, record inflation, interest rate hikes, a surging US dollar, supply disruptions, slowing growth. The “Great Moderation" of the past has been replaced by the “Great Volatility".

Clearly, uncertainty is not good for the economy or financial markets. Volatility in economic variables also creates uncertainty in policy. That forces businesses to postpone investment, while households put off non-essential purchases and foreign capital inflows decline. Much of that is happening now.

You might also like 

Adani eyes stake in Bengaluru airport 

The Android of smart home ecosystems is here

Why Mahindra & Mahindra is hitching a tractor ride

Never mind Sept quarter blip, Trent looks good

Uncertainty and investment Economic uncertainty impacts the real economy. Research conducted by the Economic Survey of India (2018-19) showed that investment growth is negatively correlated to uncertainty (as measured by the EPU index). A shock increase in uncertainty was found to impact investment growth adversely for about five quarters, and reduce foreign capital inflows. A Reserve Bank of India study in 2020 concluded that sudden jumps in uncertainty could significantly dampen investment as well as economic growth.

Note, for example, that the uncertainty spike caused by the 2008 financial crisis dampened India’s investment growth until the last quarter of 2009. Similarly, investment growth took more than a year to return after the May 2013 taper tantrums. On the other hand, investment grew steadily during the less-uncertain period from end-2009 to mid-2011.

Based on these trends, a post-covid rebound in investment should have occurred this year. The fact that it has not suggests an investment stalling caused by rising uncertainty.

Chart-2
View Full Image
Chart-2

Stock markets In stock markets, uncertainty is gauged by the VIX or volatility index, also known as the “fear gauge". The India VIX index is calculated on the basis of prices of near-term Nifty index options. When share prices are volatile, investors tend to hedge their exposures through options, thus pushing up option premiums. Thus, VIX values spike when there is fear and uncertainty about the future direction of the market.

VIX often leads the EPU index. For instance, VIX shot up a month before the May 2014 general elections as positions were covered, but dropped quickly. However, EPU peaked only in May that year, and came down much slower. Similarly, VIX peaked when covid-19 was declared a pandemic in March 2020, while EPU took another two months to reach its peak. That is because VIX is a forward-looking measure by itself, while EPU is a real-time uncertainty tracker. The relative stability of VIX during recent months, if maintained, may indicate a decline in uncertainty.

Managing uncertainty An uncertainty index is not just a gauge of the investment climate. It can be proactively used to benefit growth. That’s because some factors behind uncertainty are country-specific, while others have a global impact. For example, the pandemic led to worldwide uncertainty, the taper tantrums impacted a few emerging economies, and the uncertainty caused by the 2011-12 “policy paralysis" period was unique to India. By unpacking the underlying reasons for a rise or fall in uncertainty, policies can be designed to manage it.

Policymakers have little control over the reasons for the heightened uncertainty in 2022. However, reducing domestic impediments to growth mitigates some of the damage from external events. The current strategy of increasing capital expenditure for infrastructure building, or increasing the scope of the Production Linked Incentive scheme are steps in this direction. Creating investment-friendly systems makes us ready to benefit when this wave of uncertainty subsides.

Deepa Vasudevan is an independent writer in economics and finance.

Elsewhere in Mint

In Opinion, Manu Joseph tells what the success of T20 teaches us about the old school. Vivan Sharan writes on the lessons for India from the FTX saga. Barry Eichengreen explains the trilemma of CBDCs. Long Story reveals how the Chinese use Indians as fronts for scams.

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less

Recommended For You

Trending Stocks

×
Get alerts on WhatsApp
Set Preferences My ReadsWatchlistFeedbackRedeem a Gift CardLogout