Fast changing economic conditions should bring prudential risk management into policy focus
In about a week, the Indian government will have presented its budget for 2022-23, and a week later, the Reserve Bank of India (RBI) will announce its monetary policy decision. That will be its last meeting for the current financial year. What is the global backdrop to these two events?
It has been an interesting month already. Financial markets globally—particularly equities—are in a swoon. Bond yields are up and so are equity yields. While it is not clear why exactly US stock investors are nervous, it may be worries that the Federal Reserve would either hike interest rates sufficiently such that America’s inflation rate collapses, or not do so, leaving inflation raging.
The real economic growth rate in China in the last quarter of the calendar year 2021 dropped to around 4%, and its growth rate for the full year was around 8%. The low-base effect played its part there. China was touted as one of the very few economies that registered positive economic growth in 2020. Other countries widely copied its covid management template—still being followed by Beijing—much to their detriment. The long-term cost will be even more substantial. Note that the German economy has entered a recession.
While the discussion in many central banks around the world is about raising interest rates, China had to start the year with cuts to a couple of interest rates. The People’s Bank of China (PBoC) has also supported the Chinese economy with liquidity provisions. Firing off his beginning-of-the-year missive, veteran investor Jeremy Grantham of GMO had this to say: “In China, real estate has played an unusually important and unique role in the extended boom and thereby poses an equally unique risk to the economy and hence the rest of the world if its real estate market loses air exactly as it appears to be doing as we sit." (‘Let the Wild Rumpus Begin’, 20 January 2022).
More interestingly, Chinese President Xi Jinping, using the occasion of his address to the World Economic Forum at Davos, exhorted central banks of the West to raise interest rates slowly and not drastically. Higher US interest rates raise funding costs for Chinese corporations in dollars. Much Chinese dollar debt is due for repayment. Refinancing costs will rise if America decides to tackle its high inflation rate. This appeal for moderation in rate increases in the West from China gives us an indication of the extent to which the Fed’s accommodative monetary policy has served Chinese interests in the last 15 years or so.
Indeed, it underscores the limitations of China’s ability to pursue structural reforms, compared to the “decadent West", as many put it. The reality is far more nuanced. China’s economic model too has been built on leverage and monetary accommodation. Given the global levels of accumulated debt, the ability of several economies around the world— China, the US, Eurozone and several others—to withstand higher interest rates stands considerably diminished.
The US too is not in a position to allow interest rates to go up by much, not only because debt levels are high but also because its economy may be facing a situation of stagflation. The monthly survey of small businesses conducted by the National Federation of Independent Businesses in America is widely viewed as a key barometer of underlying economic conditions. The latest report says, “Owners expecting better business conditions over the next six months increased three points to a net negative 35%. Owners remain pessimistic about future economic conditions as this indicator has declined 23 points over the past six months."
As far as India’s economy is concerned, it appears that an average real gross domestic product (GDP) growth rate of around 9.0% can be assumed for the financial years 2021-22 and 2022-23. In its January 2022 monthly bulletin, RBI notes that Omicron infections in India have been more of a flash-flood than a wave. The central bank is right. Therefore, it should leave no lasting damage to the economy. What was more heartening to read in the monthly assessment is that capital expenditure undertaken by state governments has gone up by 67.6% in the period April-November 2021.
Looking further beyond, a steady-state average real GDP growth rate of around 6.7% to 7.0% can be a reasonably conservative assumption for India for the rest of the decade. Repeating the recent export performance could be a challenge, as the world economy is likely to face several growth obstacles, not least from the risk of a significant correction in asset prices.
I would take Jeremy Grantham’s view seriously here: “If valuations across all of these asset classes return even two-thirds of the way back to historical norms, total wealth losses will be on the order of $35 trillion in the U.S. alone. If this negative wealth and income effect are compounded by inflationary pressures from energy, food, and other shortages, we will have serious economic problems."
The other big risk that the Indian economy faces is one of a rising import bill for crude oil, brought on by a combination of a chaotic global green transition, curtailed upstream investments in oil extraction and geopolitical conflicts. Globally, this oil-price risk is not being taken seriously because it is barely understood. So too in India. In the coming years, our public policy must become more innovative and flexible in managing that risk.
V. Anantha Nageswaran is visiting distinguished professor of economics at Krea University. These are the author’s personal views.