The core message of the latest World Economic Outlook (WEO) report from the International Monetary Fund, which publishes two WEO reports each year (in April and October), as well as two updates (January and July), to policymakers around the world: “The worst is yet to come”. to come” for the world economy.
Although it does not spell out the dreaded word “stagflation”—an acronym that describes an economic state in which growth stagnates (or contracts) even while inflation remains high and persistent—the IMF separately states that “more than one third of the world economy will contract this year or next, while the three largest economies—the United States, the European Union, and China—will remain stagnant” and that “increasing price pressures remain the most immediate threat to prosperity current and future by reducing real incomes and undermining macroeconomic stability.
Persistently high inflation and stagnant growth is possibly the most difficult policy challenge available. This is because policy measures to contain inflation tend to further reduce growth, while measures taken to boost growth tend to boost inflation. Perhaps that is why the foreword to the latest WEO report, written by Pierre-Olivier Gourinchas (the Economic Adviser), begins by stating: “As storm clouds gather, policymakers need to keep a steady hand”.
As Figure 1 shows, the IMF has drastically cut the global growth forecast: from 6.0% in 2021 to 3.2% in 2022 and 2.7% in 2023. Except for the global financial crisis of 2008 and the strong drop in the immediate aftermath of the Covid pandemic in 2020, this is the weakest growth profile for the world since 2001.
On his official blog, Gourinchas explains both causes: “The global economy continues to face major challenges, shaped by the Russian invasion of Ukraine, a cost-of-living crisis caused by persistent and rising inflationary pressures, and the slowdown in China.” — and the effect — “Overall, this year’s shocks will reopen economic wounds that were only partially healed after the pandemic. In short, the worst is yet to come, and for many people, 2023 will feel like a recession.”
Global inflation is now expected to peak at 9.5% by the end of 2022 (see CHART 2). It is expected to remain elevated for longer than previously imagined and is likely to decline to 4.1 percent by 2024 alone.
A particular concern here is the path of core inflation, that is, the rate of inflation when food and fuel prices are factored out. Core inflation typically rises and falls more gradually than food and fuel inflation.
“Global core inflation, measured excluding food and energy prices, is expected to be 6.6% on a fourth-quarter to fourth-quarter basis, reflecting the transmission of energy prices, pressure of supply chain costs and labor shortages. markets, especially in advanced economies,” says the IMF. In other words, food and fuel price inflation, which has normally triggered headline inflation, has now trickled down into core inflation and as such will take longer to die down.
Downside risks to these projections
The IMF has also detailed various downside risks, or reasons why things may be worse than anticipated.
The first risk is that of miscalibration of policies. Given the precarious situation facing most economies, as well as the enormous uncertainty about what lies ahead, this is the biggest concern.
For example, fiscal and monetary policies should not go against each other. Case in point: what happened recently in the UK, where the Liz Truss government resorted to expansionary fiscal policy (tax cuts and unfunded spending increases) even as the Bank of England was trying to raise interest rates. to contain historically high inflation. The result was a mini-financial collapse in which investors lost confidence in politicians and sold British assets (gilts and sterling).
Even when fiscal and monetary policies are aligned, there can be other errors. For example, monetary policymakers may tighten their stance too much (ie raise interest rates more than required) or do the opposite. Too much tightening risks stalling growth, while too little tightening risks inflation leaking into core inflation and taking longer to contain.
Another big cause for concern is financial stability and its interaction with a stronger US dollar. Whether it be pension funds in the UK or over-leveraged countries and companies elsewhere, a drastic revision in interest rates is likely to expose the weakest links in the global credit chain.
Finally, there are geopolitical risks associated with the war in Ukraine. A worsening or prolongation of the conflict can aggravate all the pressures mentioned above.
What it means for India
At first glance, India appears to be better off. India’s GDP growth rate is better and inflation is not as high. But these metrics hide that, in absolute terms, India is barely out of the contraction suffered in 2020, which was home to the majority of people (5.6 crores, according to the World Bank) pushed below poverty. extreme in 2020 or crores of rupees are unemployed.
Furthermore, if the RBI lowers its growth rate forecast in April (7.2%) by the same amount as the IMF has (1.4 percentage points), India’s growth in 2022-23 will be 5, 8%.
The threat to India comes from at least four sources: higher crude oil and fertilizer prices will drive up domestic inflation; the global slowdown will affect exports, dragging down domestic growth and worsening the trade deficit; a strong dollar will put pressure on the rupee exchange rate, likely resulting in a reduction in our foreign exchange reserves and a reduction in our ability to import goods when the going gets tougher. Also, given low demand among most Indians, the government may be forced to spend more to provide basic aid in the form of food and fertilizer subsidies. This will worsen the financial health of the government.