optimism. Economy picking up steam amidst accentuation of global risks, says RBI

The Indian economy is picking up steam, although the recovery is uneven and trudging through soft patches, amidst an accentuation of global risks, according to an article in the Reserve Bank of India’s latest monthly bulletin.

The step-up in vaccination, slump in new cases/mortality rates, and normalising mobility has rebuilt confidence, per the article “State of the Economy.”

“Domestic demand is gaining strength while aggregate supply conditions are recouping, powered by the robust performance of Kharif agricultural production and revival in manufacturing and services.

“Softer than expected, food prices have eased headline inflation into a closer alignment with the target,” a group of 20 RBI officials led by RBI Deputy Governor MD Patra said.

Looking ahead from here, the main downside to the prospects for the Indian economy, abstracting from the pandemic, is the possibility of a sudden accentuation of global risks, cautioned the officials.

Risk of normalisation just as activity loses momentum

“As pent-up demand collides with supply shortfalls, price pressures are inducing policy authorities to scale back stimuli.

“Yet, with the recent easing of the pace of the global recovery, there is a risk that fiscal and monetary policies may normalise just as activity loses momentum,” the authors said.

Further, the global economy may have to deal with new pandemic waves and stimulus withdrawal simultaneously.

The authors opined that: “Everywhere, resurgent demand is being choked by supply bottlenecks, placing the global recovery at risk.

“In fact, supply chain disruptions seem to be feeding on one another, amplified simultaneously by decarbonisation drives and trade wars.”

Labour shortages

The officials underscored that global labour shortages are hamstringing factory output and stalling vital services like transportation as people opt out of the workforce.

They observed that as margins get squeezed and prices get pushed up, elevated inflation levels with considerable cross-country heterogeneity reflect these demand-supply imbalances and the intense competition among countries for natural resources and key intermediates – the most recent one being energy.

These developments are forcing the hands of central banks and fiscal authorities to scale back their pandemic policies, led by emerging economies, and this is shaping into another headwind to global growth.

The authors referred to a consensus that seems to veer around the prognosis that supply gaps and impediments will last at least through the better part of 2022.

“The fear is that in the interregnum, second-round effects may set in, entrenching inflation while growth suffers stagnation. There is also the possibility of facing an inventory recession when the supply backlogs are eventually cleared,” they said.

Per the article, there is an urgency now around speeding up vaccination of the world, but in these evolving configurations, it is becoming increasingly clear that vaccination alone will not boost the global economy.

“The other factors that are at work need to be addressed by the right mix of policies and coordinated across borders to keep the recovery going.

Warning signals from financial markets

“Already financial markets are sending warning signals - equity prices are wobbling, spooked by the rise in bond yields, and currencies are wilting in the face of the strength of the US dollar,” the authors said.

The officials emphasised that markets fear that the inevitable rise in interest rates will be driven by an increase in inflation rather than a rise in growth.

They suggested that:“...Perhaps the need of the hour is not to focus so single-mindedly on normalisation but on supply-side reforms to ease the bottlenecks and disruptions, labour shortages and high commodity prices, especially of crude.”

Going forward, the focus is likely to be on the normalisation of prudential policies and the strengthening of insolvency frameworks and restructuring mechanisms, including for the overhang of public and private debt, the article said.

The authors stated that: “In particular, the choice of policy mix will need careful consideration and sensitivity as it is expected that employment may weigh on the recovery, with people having lost incomes and jobs, and those that have jobs have lost purchasing power.

“Already, hiring prospects are brightening ahead of the festivals, with entry-level hiring growing at the fastest pace.”

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