India’s economy seems relatively safe but a global policy unwind would have heavy repercussions
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Another year winds down and we are all another year older. While it may sound cliched to say that we may not be wiser for that, it has more than a ring of truth now than at any time in recent memory. Even before the genomic sequence of Omicron was fully figured out, most countries shut down foreign travel and the media doused the reading public with a liberal dose of fear bordering on paranoia, leaving us all with more and not less uncertainty, concern and weariness as we looked forward to a better 2022.
While pharmaceutical companies have an obvious interest in keeping fears of the virus up and calling for more frequent and endless doses of vaccination, some financial interests too would prefer to prolong fear and uncertainty because this would keep central banks in easing mode. Monetary authorities would be reluctant to reduce their provisions of liquidity to economies even though these flows mostly fund speculative activity. Should fear and uncertainty persist, European economies would be more vulnerable than most and the euro will be a sitting duck. The continent is in the midst of political transition in several key countries and their policies are yet to be tested. The European Central Bank has gone in for unprecedented monetary accommodation, which has pushed the inflation rate in Germany to over 5%, the highest since 1992.
In another time and age, the German Bundesbank would have erupted in anger and raised interest rates even if that brought the economy to its knees. Now, all that the Bundesbank president could do was retire from his post, five years earlier. The times, they are different now.
Amid this pandemic of fear, the re- appointed chairperson of the US Federal Reserve appears determined to pare back bond purchases which have kept government bond yields rather low, in spite of record borrowing by the US government. Inflation, as measured by its official consumer price index, is at 6.88%, the highest in nearly four decades. This has brought the real short rate (real 90-day T-Bill secondary market rate) to a level slightly greater than last seen in June 1980. It was -7.2% then and is -6.83% now. But, the real Federal Funds rate has not been this low in the 67 years of data that is available in the FRED database.
It suits a debt-heavy American economy to have such a negative real short rate. It is part of the US toolkit to keep debt serviceable and lower the debt burden relative to gross domestic product (GDP). This is how many developed countries dissolved their debt mountain after World War II. But growth was high too, then. This time around, growth will be missing from the equation.
That sets up the potential once-in-a-generation clash between capital and labour. High growth then had kept both capital and labour in balance. Now, high inflation will squeeze real wages. Preventing that would entail squeezing profits, given structural growth headwinds in many parts of the developed world. That should set up conditions for a stock-price crash. This is overdue. Consequently, the Federal Funds rate would peak at around 1.0% or less in this cycle, as a recent article in Barron’s argues (bit.ly/3DPcIZt).
In a normal world, this would be very bad news for the US dollar, as it would lack interest rate support. But the euro, its nearest rival, is more beleaguered. That brings us to China.
Most commentators who rightly hold the US responsible for all that appears broken in the world of capitalism somehow find their voices muted when it comes to holding China’s policymakers responsible for the mess that its economy is in. China, in their view, is more willing to confront its economic challenges head on. Facts do not support such sanguinity. An investigation of alleged links between the People’s Bank of China (PBoC) and the country’s financial sector had set the stage for coercion by the Communist Party to ease reserve requirements for banks. According to LingLing Wei, party inspectors have lectured officials of China’s central bank that “whatever macro-policy discipline the central bank tries to maintain would be secondary to the need to deliver what the party leadership asks." (on.wsj.com/3DRZJpM). This is not going to give America sleepless nights about the dollar losing its reserve currency status anytime soon.
India looks relatively better off, but with several key state elections approaching, economic policy is still a knife-edge walk. While the Reserve Bank of India appears right to have left its monetary policy in accommodative mode, memories of 2013 will be fresh in policymakers’ minds, as the rupee then had collapsed because of monetary and fiscal stimulus actions that overstayed their welcome. The conditions now are different. Fiscal policy is not loose and the current account deficit is low but could be approaching 3% of GDP. But asset markets are more expensive now. So, a meaningful global asset price correction, with Indian stocks falling in its wake, should not be unwelcome in Indian policy circles.
There are plenty of geopolitical and geo-economic risks, with both feeding off each other as we head into 2022. There will be light at the end of the tunnel, but we must get across it first.
V. Anantha Nageswaran is visiting distinguished professor of economics at Krea University. These are the author’s personal views.
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