What Lies Ahead? Future of Economy through Crystal Ball

Economies and capital markets are in turmoil.  Inflation is at record high. Global shares are down 25% in dollar term.  US Fed has raised interest rates five times so far in calendar year 22.  But inflation still remain in double digit.  Europe is facing double whammy of inflation and energy crisis.   Soaring price of food and energy is causing serious problem for people. Many face situation where they will have to choose between eating or heating as winter is closing in.  As global inflation remain stubborn, monetary authorities around the world are in dilemma about how much could they raise interest rates without risking pushing economies into recession.   Geopolitical tensions and conflicts are compounding already prevailing grave situation.

As trends in world economy give no clue as to where it is, or will be, heading,   Crystal gazing is only what economists and governments around the world can do at the moment.

According to KPMG India 2022 CEO Outlook survey, overwhelming number of CEOs globally and in India have already crystal gazed global economic outlook into recession in the next 12 months.   They have all the logical reasons pointing towards that. 

When I look through crystal guessing ball myself, I clearly see the other side a new normal emerging. Sooner the nations acknowledge and accept this new normal, better for their economies.

But as we first look back to find roots of today’s economic rot, we find that for years since the financial crisis of 2007-09, the central banks in America and Europe kept lowering interest rates uninterrupted all the way to near zero and in some European countries and in Japan to negative interest rates.  This left no room for monetary policy to boost economy when pandemic struck out of blue.  The fiscal stimulus was only option left. The result was unprecedented stimulus by way of massive quantitative easing and doling out cash in US, UK and elsewhere in Europe.  What was envisaged as instrument to revive economy was actually acting as temporary props to hold economy aloft.  As pandemic started receding, people started spending money they received as gratis.  In addition, instead of changing gear from stimulus to restraints, the governments continued with loose fiscal policy.  The result of which we see today with bewilderment as global inflation surged to above 9%.  The Russia-Ukraine conflict fuelled inflation further with food and energy prices surging upwards.  The panic alarms were set as most of the central banks started raising interest rate multiple times in 2022 to tame the inflation.  Inflation targeting is seen by them as solitary challenge.  But so as to avert effect of economic slowdown due to tightening of monetary policy, governments are forced to continue with loose fiscal policies of tax cuts and subsidies.  This has made fight against inflation difficult.  From near zero, the interest rates are moving in opposite direction, again uninterrupted.

How much can central banks hike the interest rates?

Here is the new normal sets in.  The governments and central banks will have to come to terms with higher threshold for inflation before monetary measures must kick in. 

As I move my gaze from global to Indian economy, I clearly see hope. 

And again as we look back, we find answer in the Government of India’s immediate response to pandemic induced slowdown.  It was a well-calibrated response with a bouquet of safety-nets to cushion the impact on vulnerable sections of society as well as the business sector at the same time. The government realised early both must be provided support to sustain. Alongside a significant increase in capital expenditure on infrastructure to build back medium-term demand as well as aggressively implemented supply-side measures prepared the economy for a sustained long-term expansion.

Realising that support system was needed for India’s MSMEs, which contribute to 30% of GDP and employ more than 100 million workers, the government quickly rolled out plethora of support schemes to tide over Covid-19 woes. 

To promote manufacturing in India with view to insulate itself from future global supply chain disruption and make India self- reliant as well the manufacturing hub for Indian global companies, the government launched Productivity Linked Incentives (PLI) scheme. PLI offers financial incentives to boost manufacturing and attract large-scale investments. It is output oriented and gives out incentives based on performance and not promises. So, if a manufacturer makes, say, USD1 million of incremental sales of goods under PLI, he can get USD 50,000 as cash-back. Similarly, there are sector-specific clusters being developed. 

There are several problems remain to be ironed out in those schemes and initiatives. But the government is working on to address them.  Like to provide the world-class infrastructure for manufacturing, the government recently launched National Logistics Policy with objective to make Indian goods more competitive while also promoting economic growth and expanding job possibilities.

Due to such calibrated and long-term measures by Indian government in last three years, despite inflation around 7.4, the economy is expected to grow around 6%.  It has remained a ‘bright spot on the dark horizon’, according to IMF. 

Turning back to present and future, I remain optimistic as I see lot of factors to be optimistic about.

• Large domestic market is the biggest positive. With per capital rising and poverty rate falling, this will work in our advantage if the world slips into recession as feared.

• Much of the outcome of PLI will start trickling in from early 2023 as companies shift gears from processing stage to executing the projects. PLI has already created around 450,000 jobs and the government expects that eventually 6 million additional jobs will be created.  However, tedious paperwork and approval process will have to be addressed. Also currently manufacturing depends on getting components from outside. The next PLI should focus on components and sub-assemblies and aim to reduce the imports to make manufacturing globally more competitive.

• India has been aggressively pursuing FTAs.  We have recently concluded with UAE and Australia.  We are in talks with UK and we hope to have one with EU next year.  This will boost manufacturing-led exports.

• Over the last few years, we have had record foreign direct investment including in 2021 which witnessed the highest ever FDI of USD 82 billion.  This demonstrate international investors’ confidence in India growth story.

• India is an island of stability, amid the on-going geopolitical disturbances.

• Continuing Structural reforms, macroeconomic stability, predictable policy, business friendly ecosystem, reliable broadband penetration across the country, robust digital infrastructure a democratic, rule-based, open and investment friendly economy.

• According to a survey, Indian business leaders have put in place resilient mechanism to prepare them to withstand any looming global recession.

With such strong and robust economy in place, I see India unlikely to face recession.  However, RBI also must acknowledge the new normal and not worry much about inflation.  Continuing with the stance of hiking rates will be detrimental to otherwise resilient Indian economy.