Risks to recovery

Global economy will increase policy complications for India

The third year of the pandemic has started on a weaker than expected note for the global economy. The renewed spread of Covid-19 infection shows that the economic outlook will remain uncertain for some more time. Although symptoms in the currently prevalent Omicron variant are said to be less severe, it is far more transmissible than earlier variants. Mobility restrictions, as a result, have been imposed in various parts of the world, which would affect the ongoing recovery. The International Monetary Fund (IMF) in its latest World Economic Outlook update has thus revised its forecast downwards for the global economy. It now expects global growth to moderate to 4.4 per cent in 2022, which is half a percentage point lower than the October 2021 estimate. The global economy is expected to have grown by 5.9 per cent in 2021. The IMF also lowered India’s growth forecast for the current fiscal year by 50 basis points to 9 per cent and increased next year’s to the same level.

Although the baseline projections have incorporated the effects of Omicron, the risk is tilted towards the downside. Differently put, global economic growth could moderate further during the course of the year, depending on the pandemic situation, among other things. Higher than expected global inflation and resultant monetary policy action by large central banks could also affect the pace of output expansion. For the US, with higher inflation and large pent-up demand in the system, the IMF notes that the monetary policy will need to be tightened. The IMF forecasts assume that the Fed will end its asset purchase programme by March 2022, and increase rates thrice both in 2022 and 2023. This would be needed to bring down the inflation rate to the medium-term target of 2 per cent. The markets, however, expect the Fed to increase rates four times in 2022. The expected early withdrawal of monetary accommodation and continued supply-side constraints, among other factors, have resulted in the lowering of IMF’s growth forecast for the US by 1.2 percentage points in the current year. Further, the European Central Bank will end its net asset purchase under the emergency programme by March 2022. Meanwhile, the Chinese economy is also expected to slow down.

The overall change in forecasts for India is not very significant, but higher global inflation and slowing growth could increase policy complications. According to the first advance estimates, the Indian economy is expected to grow by 9.2 per cent in the current fiscal year, which is close to the IMF’s projection of 9 per cent. However, it is important to recognise that since the economy expanded by 13.7 per cent in the first half of the fiscal year, the growth in the second half is expected to have slowed to under 5 per cent. The first half of the next fiscal year would again see higher growth because of a favourable base, as economic activity suffered during the second wave of the pandemic. Thus, the challenge for Indian policymakers is to strengthen the recovery at a time when the global economy is slowing, and they would need to start rolling back both fiscal and monetary accommodation. The Union Budget next week will be the first policy test in this context.