Watch out for adverse economic spillovers from Western economies

A misreading of inflation by the US Federal Reserve or unexpected interest rate moves can impart huge volatility to the global economy.
A misreading of inflation by the US Federal Reserve or unexpected interest rate moves can impart huge volatility to the global economy.

Summary

  • While Israel-Iran, Russia-Ukraine and China dominate global headlines, what must be kept at the centre of India’s risk radar are policy shifts in the rich world—especially in the US. Policymakers should keep a response kit ready for disruptions.

With a barrage of missiles and bombs flying across the land in West Asia, all eyes remain fixed on the next moves by Israel and Iran. An escalation in hostilities could potentially lead to much higher oil prices and result in inflation. 

However, this is happening at a time when the Organization of the Petroleum Exporting Countries (OPEC+) is tilting towards higher oil production and the global economy remains weak, limiting the upside risk to oil prices and thus inflation as well as interest rates thus far.

Indeed, the world has seen some unprecedented times, lately. The war between Russia and Ukraine has gained dangerous proportions after having dragged on for more than two years now. Yet, the world has somehow managed to cope with the aftermath so far.

The realized experience over time also suggests there has been a procession of negative ‘spillovers’ from advanced Western economies. Europe too has been a source of shock-waves. 

Also read: India braces for economic strain as West Asia conflict escalates

Think of Grexit, or the idea of Greece leaving the EU just like Britain did with Brexit, the EU’s Carbon Border Adjustment Mechanism (CBAM), other overarching global regulations and the increased use of tariff barriers, apart from the recent rise of extreme political parties of the left and right across the European continent.

Scary headlines do paint a picture of brinksmanship and a world headed for huge structural challenges on all fronts: i.e., demographic, economic, environmental and geopolitical. However, it is the US that is the real ‘known-unknown’ from an economic risk standpoint. 

Potential risks emanating from American shores could extract a toll from the global as well as Indian economy. The US should be at the centre of the radar that policymakers and risk managers watch in the medium term.

Narratives matter as much as actual events and what we hear coming out of the US are not very promising. In fact, America has made the world’s biggest economic U-turn from hyper-globalization to a muscular industrial policy, considered anathema to economic policymaking until not too long ago. 

The tripling of import tariffs on Chinese steel make Republican presidential candidate and former president Donald Trump’s plan of imposing a 10% tariff on all imports look tame. But there could still be more shockwaves from the US.

Debt and the US fisc: John Conally’s quip in the 1970s that “the dollar is our currency but it’s your problem" is alive and kicking, and one may also have to add US debt and deficits as the world’s problems.

In fact, on the first day of America’s new fiscal year on 1 October, it added $204 billion to its debt, taking it to a record $35.7 trillion.

For context, India’s fiscal deficit for 2024-25 is about $190 billion. US debt remains massive and its debt sustainability is starting to look riskier as it adds more than $1 trillion in debt every 100 days. 

Also read: Mint Primer | Iranian missile strikes: How to bell the cat now?

Irrespective of who wins the November election to the US White House, debt will only rise further as it is unlikely that either side of the political spectrum is amenable to restraining spending or raising taxes materially. 

As the price of US Treasuries underpins global pricing in financial markets, higher volatility is a key risk. The US is expected to notch up a fiscal deficit of 7.1% of GDP in 2025, which is more than three times the advanced economy average (and likewise relative to its own fiscal past).

The dollar and the US Fed: A misreading of inflation by the US Federal Reserve or unexpected interest rate moves can impart huge volatility to the global economy.

Aggressive rate cuts by the US central bank can also have an important bearing on Indian policy rates. Sharp moves in the dollar could impact trade and financial channels, given the currency’s role in global bank funding, payment systems and reserves.

There is also talk that a probable Trump administration would turn into an ‘exchange rate warrior’ in favour of a cheap dollar and use the US currency’s devaluation as a tool to reduce the American trade deficit, especially with China, on top of trade tariffs of the kind used during Trump’s first term in office.

Countries, including India, could get dubbed ‘currency manipulators’ or punished for routine operations. Trade relations could get complicated. Remember the withdrawal of India’s preferential status under the Generalized System of Preferences? 

Candidate Trump has warned of a ‘100% tariff’ for countries that try to ‘de-dollarize’ or actively seek ways to engage in bilateral trade in currencies other than the American dollar.

The US political and societal chasm: Some observers aver that the 2024 election will test American democracy to a degree that hasn’t been seen in the last 150-odd years. Bipartisan comity has become extremely rare in the US. 

The US Congress even threatened to default on Treasuries during the debt-ceiling crisis of 2021 and 2023. Any dramatic shift in its foreign policy and economic management after the election is sure to have global repercussions.

Also read: A time to choose between growth and expansionism

Thus, while Israel-Iran, Russia-Ukraine and China dominate global headlines, make no mistake—it is the West, and especially the US, that could unleash durable negative policy spillovers. Indian policymakers must stand prepared with a standard operating procedure for such disruptions.

These are the author’s personal views.

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

MINT SPECIALS