Rising global risks: India will need policy space

Given the global economic outlook, the policy focus should be to first preserve financial stability and not take undue policy risks

The latest assessment by economists at the Reserve Bank of India, published in the October Bulletin, has rightly underlined the increased global economic risks. There are a number of factors affecting the global economy that have further worsened the outlook. Higher global inflation is likely to persist for some time, resulting in sustained monetary tightening. The ongoing Ukraine war remains a big risk for the global economy. Although it is partly being played out in the form of higher energy prices, which have added to the general price pressure, the war can suddenly worsen things in many ways. The conflict, in a way, is also reshaping the terms of engagement among important countries. A setback to global cooperation and increased geopolitical tensions would hurt longer-term economic prospects. Meanwhile, the slowdown in China and potential stress in its financial sector are also risks for the global economy.

The Chinese slowdown may play out over a period of time, and since it has been a major driver of global growth over the years, this would weaken overall growth. Although the Ukraine war remains a big risk in the near term, economists at the moment are more worried about higher inflation, particularly in advanced economies. The inflation rate in the US, for example, continues to surprise on the upside. While the headline inflation rate for September came at 8.2 per cent, core inflation at 6.6 per cent was the highest in four decades. This suggests that inflation is unlikely to come down very quickly. The minutes of the Federal Reserve’s latest policy meeting show that some participants believe the cost of doing too little to contain inflation could be more than doing too much. Some commentators have highlighted the risk of excess tightening.

Financial markets, however, now expect the Fed to increase the policy rate by another 75 basis points in November. The condition in Europe is not very different. The inflation rate in the euro area increased to 10 per cent in September, while it was at 9.9 per cent in August in the UK. The tightening of monetary policy in advanced economies, particularly the US, is not only a risk for growth but also financial stability. A sustained increase in interest rates and global uncertainty will further push capital out of developing economies. As the International Monetary Fund (IMF) has highlighted, eight low-income countries are in debt distress and several such economies could face a debt crisis. Higher interest rates and overall uncertainty could also potentially destabilise financial markets even in advanced economies as was seen in the UK recently.

Growth projections for the Indian economy have also been lowered by most agencies. The IMF, for instance, expects the Indian economy to expand by 6.8 per cent in the current fiscal year. While the current year’s headline number would look higher because of the first-quarter base effect, projections for the next fiscal year will face significant risks. Given the global economic outlook, the policy focus should be to first preserve financial stability. Next year is likely to be more challenging with significantly tighter global financial conditions and slower economic growth. Indian policymakers would, therefore, do well to create and preserve policy space to deal with potential global shocks. This is not the time for policy risks.