By Anjan Roy
Is the world staring at a recession? The question is coming up fast as there is serious concern that is going around. The global central banks’ policy moves to tame inflation could initiate a recession and larger unemployment.
We have so far known of the Russian revolution of 1917 as “The Ten Days That Shook the World”. Now another such observation is gaining currency.
The London-based Economist magazine is referring the policy reset of world’s major central banks as “eight days that shook the markets”. It says that beginning with the Central Bank of Australia, raising interest rate, the European Central Bank, Bank of Japan and then the US Federal Reserve have jacked up their policy rates.
The Reserve Bank of India (RBI) had even anticipated these and raised interest rates earlier on. RBI is effectively saying that unless inflation is brought under control, further rate hikes could be on cards. Of course, RBI is cautioning that given the fragile state of the economy in the wake of the still-ongoing two-year Covid pandemic, it is also imperative that the growth triggers are not muted.
There is certain amount of panic nonetheless. Interest rate hikes are creating a situation in the financial markets which are anathema to growth. Already, the global financial markets are in a tizzy. It is but inescapable with a policy rate hike.
There are two aspects of the current rate rises. First, the interest rates are being raised primarily to fight inflation. Across the world, prices are rising. In some countries price rise has been unprecedented. USA, for one, saw the latest inflation print of 8.6% which is said to be highest in forty years.
The price rise is so steep that people are getting furious. The US president, Joe Biden, is publicly seeking to reassure Americans that he would do everything to bring down prices and the consequent hardship. This assumes greater urgency in the context of the upcoming mid-term elections.
Secondly, the interest rates hikes were being talked of for sometime now as a corrective measure for the extraordinary monetary policies followed to fight the adverse effects of the pandemic. The pandemic led to contraction of economies, more so in the emerging markets and in the poorer countries.
Subsidies and handouts were offered to people to help them overcome the loss of income from lockdowns and loss of jobs. Fiscal deficits had widened in most countries. In fact, the accommodative stances had started from the 2008 global financial melt-down and in mild forms continuing. These would have to be reversed sometime or other and policy parameters had to come within normal levels.
However, whenever interest rates are raised -and some of the recent hikes have been rather steep like US Fed’s by 75 basis points- inevitable reactions would follow.
With the US Fed rate hike, the American stock market has plummeted. Whenever interest rates rise, socks decline as the arbitrage equilibrium between stocks and bonds change. Bond yields rise, with bond price fall. Investors get risk averse and shift any from stocks.
These changes in the financial markets are then transferred to the real economy. The real economy starts adjusting to the changed financial market and firms get affected. Their plans for investment or their valuations go down and as a result a process of adjustment sets in.
These adjustments invariably lead to larger unemployment, a precursor to a full-blown recession. So the question is now, will the current round of rate hikes and financial turmoil result in larger unemployment. Thus, to the extent current bout of inflation is defiant to the milder interventions of the central banks, the chances of a recession rise. The more the rates hikes, the more the fear of a recession.
It is as if the treatment is worse than the disease. But that is it. Assess how far the current rise in prices likely to continue. The immediate triggers for the widespread rise in prices in general across the world is one: the Ukraine war.
With the war continuing now for three months and hostilities taking on the character of a world economic war, prices cannot be seen to be stabilising in the short term. Two basic prices are being hurt: those of food and of fuel. This is a global food and fuel inflation.
If the Americans are bothered about paying out more for their gas at the petrol stations, the greater part of the globe -the middle income and poorer ones- are struggling to meet their family food bills. Some of the poorer and small countries are simply buckling under.
Even though admittedly their economies have been completely mishandled, two of India’s South Asian neighbours are crashing. For Sri Lanka, it is not a question of recession or inflation: it is a question for most people where the next meal would be at hand, or if a serious patient could reach hospital for want of transport. For Pakistan, the government is asking its citizens to cut down on their favourite drink, the poor tea, for there is not enough foreign exchange with Pakistan Central Bank to pay for it.
Fortunately for India, we are not yet in a serious economic turmoil, even though we are facing both food and fuel inflation and RBI is raising interest rates, the contractionary forces are not throttling the growth. India is expected to row by over 7 per cent in the current year and that is far from a recession by any description. However, India is an exception, as many experts are admitting, as the economy, being somewhat inward looking, is not hopelessly dependent on global uptick.
But overall the global economy, the silver lining however is that, by and large, it is not yet a recession. The Economist argues that the world economy is chugging along, even though at a slower pace, than already in the throes of a recession. For recession to bite, incomes must fall for two consecutive years. Happily, that is not the case just yet. (IPA Service)