Uncertainty Around with Higher Inflation and Lower Growth Rate

Satyendra Nayak speaks about the factors and effects of high inflation and low growth rates on the world economy

The global economy entered 2022 with an air of uncertainty. A smart recovery in the growth momentum in 2021 due to the decline of the covid after effects has been blunted again. Many economic and geopolitical factors have contributed to this uncertain environment surrounding growth prospects. The rise in the demand for oil and energy over the last two years has brought a sharp and unprecedented increase in crude oil and other energy prices. While crude oil prices have increased by 39% over the year and reached $100 a barrel, the natural gas and coal prices have gone up by 55% and 183%, respectively. The world is going through a phase of high energy cost.

Added to this is the negative effect of the Russia-Ukraine war leading to the economic sanctions from NATO on Russia. Not only is the war costing Russia and Ukraine economically, the sanctions have also caused energy supply disruptions in Europe which depends on Russian oil and gas. In order to counter these sanctions, there has been a boost in ruble trade instead of payments in dollars. China has begun paying for Russian oil in rubles leading to 1000% rise in the monthly volume of ruble-yuan trade to $4 billion. India has also begun engaging in bilateral trade with Russia with payments in rupees. With the rising ruble trade and payments, the demand for dollars in the foreign exchange market has come down.

The economic effects of covid were not as bad as the ones from the Financial Crisis and the Great Depression. Although covid’s effects were short-lived, it still did cause a sharp dent in the global economic growth. The global economy that declined by 3.6% in 2020 recovered in 2021 with a smart growth of 6.1%. But growth is expected to slow down to 3.6% in 2022 and 2023.

After the Financial Crisis, the economies were managed by larger deficit financing by the governments and a policy of monetary expansion with low-interest rates to the level of zero or sub-zero by the central banks. Now that the economy is in a situation of a large increase in oil prices and energy costs, and supply bottlenecks in essential commodities, price inflation has reached record levels. The interest rates are on the rise again and may reach the pre-crisis levels.

Added to the global economic slowdown is the inflationary environment of unprecedented proportion. The situation is truly described as Stagflation that was experienced in the 1970s and 80s. Stagnation in economic growth is accompanied by intractable inflation in prices, a pernicious economic cocktail that can damage propitious sentiments and trends in the economy. Retail price inflation in the US has reached a record of 9.1%, the highest since November 1981 when it was 8.6%. It is a massive challenge to the Federal Reserve (Fed), which pegged the inflation rate at 2%, to contain inflation now. The Fed has already raised the interest rate by 0.75% to the 1.5-1.75% range in June. By the end of 2022, the Fed Funds rate is expected to be 3.25% to 3.5% and 4% in 2023. The time the Fed now has to fight inflation and the low-interest rate phase is over.
Rising interest rates and tightening monetary policy aimed at lower money supply growth to combat inflation will have an effect on reducing the growth rate. Under the covid effect, the US economy declined by 3.5% in 2020. The growth rate recovered in 2021 to 5.6%, but is expected to be 1.7% in 2022 and lower at 0.5% in 2023. Yet the unemployment rate remains lower at 3.8% due to the fiscal spending by the government.
Indian economy which now ranks as the fifth largest globally has higher growth momentum. In the global economic environment of lower growth, India is emerging as one of the fastest growing economies in the world. China’s growth rate has slumped down due to the recent covid lockdown while India’s GDP declined by 8% in 2020 under the impact of the corona virus. The economy grew by 9.2% in 2021-22. The growth will slow down to 7.5% this year; however, the biggest worry is the raging inflation. The wholesale price index has gone up by 15% over a year and retail price inflation has reached 8%. In its attempt to curb inflation, the Reserve Bank has raised the repo rate, the rate at which the banks borrow from RBI, by 90 basis points to 4.9%. A further increase of 25-35 basis points is expected next month and by year-end, and the repo rate would go up to 5.5-5.75%.

Apart from the negative impact of the oil crisis and the Russia-Ukraine war, the growth momentum of the economy remains intact. Normal monsoons keep the agro and agro-based sectors buoyant. Covid did not have any adverse effect on food grains output which was 308 mn tonnes in 2020-21 and 310 mn tonnes in 2021-22. On the back of good rainfalls and its spread, a bumper harvest of 328 mn tonnes is expected this year. On the industrial front, the growth rate has risen to 7%. India’s service sector is large and accounts for 50% of India’s GDP. It comprises trade, banking, finance, insurance, hotels, restaurants, transport, storage, communication, housing, real estate, construction, business services, and software services. This sector, which is also more employment oriented, would generate higher growth this year than the 8.2% achieved in 2020-21.

India’s exports have shown buoyancy in 2022 with both goods and services exports growing by 22-23%. However, the hefty increase in imports primarily caused by rising oil prices has impacted the trade deficit.
The rupee has declined by more than 6% in the forex market with the dollar rate going up from `74.76 a year ago to now touching a high of `80. Rising crude oil import bill and FII sale of equities of $26 billion have contributed to this fall.

The writer is an economist and former banker. Email: ss_nayak@hotmail.com

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