Hobson's choice

Limited policy options in the US weaken efforts to push growth

The jury is still out on whether the global economy is headed for a “double-dip” recession or a prolonged period of sustained economic underperformance, wherein gross domestic product in developed economies grows at no more than one or two per cent per year. While available indicators point to the latter scenario, it is unlikely to offer more cheer than dire forecasts about a “double dip”. Ominously, the developed world seems to have blown its ammunition in terms of policy tools to confront the persisting crisis. Federal Reserve Chairman Ben Bernanke’s Jackson Hole speech virtually ruling out a third round of stimulus for now was obviously guided by fears of stoking inflation, which would only make a bad situation worse. Either Mr Bernanke was keeping his policy cards close to his chest, or he has no more aces up his sleeve. The effectiveness of monetary policy in the United States is virtually at an end. A US economic turnaround will primarily be driven by improvement in the fiscal scenario, though a road map is far from clear. It would be interesting to see for how much longer the Federal Reserve can resist pressure to print money. The US housing market is still in the doldrums (housing prices are at 2001 levels!) and the official employment rate is just a tad short of 10 per cent — just the kind of situation in which political considerations trump economic reasoning.

The situation in the Eurozone, on the other hand, is made worse by deeper limitations in policy options compared to the US and the burden of a monetary union without the accompanying fiscal consolidation. Japan’s economy is not expected to head north anytime soon — the devastation wrought by the tsunami earlier this year has only exacerbated existing problems. A persistent slowdown in the developed economies, characterised by anaemic economic growth, is likely to dampen commodity prices, which should do its bit to rein in global inflation. This is increasingly likely to be countered by rising “resource nationalism” in countries seeking to cash in on the commodities boom. Low interest rates in developed economies (The US Fed has assured that the prevailing near-zero interest rates will remain till 2013) are likely to accelerate capital flows to emerging markets by investors seeking to arbitrage differentials that higher interest rates in emerging economies provide. In response, it is likely that many emerging market economies would come up with a slew of capital controls to discourage unbridled capital flows, following South Korea and Brazil, a few years ago.

India would have to weigh its options carefully. In the near future, the rupee is likely to continue its downward trend, which ceteris paribus will boost Indian exports, currently enjoying a golden run. A persistent slowdown in the West could, however, make this boom unsustainable. If foreign institutional investors flock to India as they did prior to 2008, the rupee will head north posing a new set of challenges. The Reserve Bank of India will then have to calibrate a policy that ensures that the cost of “sterilising” foreign reserves is not prohibitive, while not creating a hostile regime for investors. Clearly, India cannot assume it will not be impacted by global trends. It needs a strategy to strengthen the domestic sources of growth and minimise the impact of external factors.