The shadows over global growth recovery are long

News: There has not been a full recovery from the aftershocks of the COVID-19 pandemic. Economic prospects have worsened. There is divergence between the economic recoveries of advanced economies and those of the developing ones.

What are the macroeconomic forces behind inadequate recovery?

Supply Chain Disruptions

There are prevailing uncertainties in global growth prospects due to frequent disruptions to worldwide supply chains in the last two years. These disruptions have been caused by the Covid-19, invasion of Ukraine by Russia, recurrent lockdowns in key manufacturing hubs.

Inflation concerns

At present, inflation has become a central concern. For 2022, inflation is projected at 5.7% in advanced economies and 8.7% in emerging market and developing economies. At present, the major contributors to high inflation are energy and food prices.

A tight fossil fuel supply and geopolitical uncertainty have caused a hike in oil and gas prices.

In developing economies, rising food prices have had cascading effects. It has led to higher overall inflation. For example, higher energy prices result in high transportation costs. Therefore, prices of input such as fertilizers, increases, resulting in higher prices of cereals.

Capital outflows

There has been a sudden spurt in capital outflows from emerging markets and developing economies in recent months due to mounting risk in the market. There have been tighter monetary conditions and rising inflation.

For example, The US Central bank has tightened interest rates.

What are the impacts?

In developing economies, higher prices for food impacts different sections of the population differently. For example, the low-income households’ strata are particularly vulnerable to price changes. They often consume diets with just one type of grain.

For developing economies, the sudden large capital outflows have resulted into currency depreciation and tighter external sector conditions.

What are the challenges to deal with economic situation?

The domestic fiscal policy space has already been eroded in many developing countries due to COVID-19-related spending.

The increase in global interest rates will further reduce this contracted fiscal space in many economies.

As per the IMF’s ‘World Economic Outlook’, the debt levels in developing countries have touched an all-time high due to huge fiscal expansion during the coronavirus pandemic.

The factors contributing to high inflation (energy and food prices which are driven by global supply shocks) are beyond the control of central banks.

The sudden capital flow reversals can threaten financial stability.

Way Forward

Monetary Policy

The Central banks need to carefully monitor the pass-through of rising international prices to domestic inflation to calibrate their responses.

The RBI should tighten monetary policy according to prevailing economic situations and activity levels.

Central banks should maintain the credibility of their inflation-targeting frameworks. It should adopt measures for inflation stabilisation.

Foreign exchange interventions could address market imbalances.

Fiscal Policy

It is important to prune expenditure and get back to the road of fiscal consolidation.

Safety nets needed

While fiscal consolidation, the government should also prioritise spending to protect and help vulnerable populations affected by price increases and the pandemic.

In the post-pandemic global economy, there is going to be transitions like the energy transition. Therefore, there will be a likely cross-sectoral labour reallocation. The government should ensure safety nets for workers. For example, temporary public support for displaced workers, training programmes and hiring subsidies

In the developing economies, the governments have to prepare for tighter financial conditions and spillovers from geopolitical volatility.

Source: The post is based on an article “The shadows over global growth recovery are long” published in the “The Hindu” on 8th June 2022.

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