IMF’s World Economic Outlook (WEO) notes that a hard landing – particularly for advanced economies – has become a much larger risk. Can policy interventions help prevent it?
Let me address this in two parts. First, if we were to have a much sharper slowdown than we anticipate in our baseline projections, if there is more financial instability… It’s not the situation right now, but let’s imagine, and then it would be totally warranted for policies to adjust to address financial stability… monetary policy would also adjust. The second part would be to say, well, maybe we have a sharper slowdown because of policies. For instance, if it turns out we don’t have financial instability, but inflation is more persistent than anticipated, then there would be a need for more policies to contain inflation. But these policies, this tightening of monetary policy, for instance, would slow down economic growth further and could bring a sharper downturn.
So, it depends on what drives the sharp slowdown or the hard landing. If it’s coming from financial instability, it’s one thing. If it’s coming from inflation being more persistent, it might require a stronger policy that will slow down the economy faster.
India has been seen as a bright spot, but is slowing down with the rest of the world. How can it accelerate growth?
In our projections for 2023-24, we have a slight slowdown of growth. Last year was about 6.8% and we’re now projecting 5.9%. So, there is a bit of a slowdown and then a rebound after that to 6.3%. The slowdown, which was already in our projections in January, is actually a little bit sharper now. It was 6.1% and now we are 5.9%. That largely reflects the fact that we’ve got some revised data for previous years, and we now think that there is less of an output gap for India. India is closer to its potential output and, so, there is less room to grow. Consumption also seems to be softening. I think for India, the key to long-term growth is going to be really to unlock more growth in potential output.
We have to think about investment in infrastructure, about different ways that we can boost potential growth, whether that includes strengthening health, including increasing access to education, or increasing female workforce participation. These different aspects, which are sort of long-standing drivers of growth but also long-standing areas of development for a country like India, are still on the table. The number of the initiatives that are in place are actually going in that direction…in particular, on infrastructure investment, for instance.
How big a risk are the developments in the banking space in the US and Europe? Do you see any spillover impact globally?
So far, we don’t. It’s quite remarkable if you look at the banking turmoil of the last month. Typically, when you have a broad episode of financial instability, you get a lot of nervousness in global markets; capital flows back to, let’s say, the US treasuries, the dollar appreciates, it becomes very difficult to obtain dollars for international borrowers, and all kinds of spreads increase. We have not seen much of that in the last month. The volatility has been contained in the banking sector in the countries that were affected – broadly in the US and Europe – and even there, it has come down quite a bit after measures were taken to address instability.
There is a growing view that banking regulation and supervisory rules need to be re-examined in the wake of recent developments in the sector in the US and EU. And that even small financial entities can imperil markets. Your view?
It’s certainly the case when you think about regulation. It’s sort of an organic set of rules and it needs to evolve over time as the financial sector transforms itself and new vulnerabilities or new types of exposure might emerge. I think some of this is definitely going to take place in the US. For instance, there is already a review of the events that led to the collapse of Silicon Valley Bank. I am sure that global regulators, whether the FSB (Financial Stability Board) or the BIS (Bank of International Settlements), would also look at what can be done to make sure that there is a proper assessment of interest rate risk which has been the main driver in the recent episode, but also after the technological transformation. One of the striking things in the US was the speed at which deposits could flow out of regional banks. In a world in which you can have digital transactions and in the world in which information spreads around much more rapidly, perhaps with the use of social media, there is something one may well want to look at what this means for how to ensure the stability of financial institutions going forward.
Inflation has proven sticky and may require interest rates to stay firm longer. What could this mean for the already fragile global financial markets?
It’s certainly the case that the very rapid increase in interest rates has created some strains and had some undesirable side effects on the financial sector. When central banks increase interest rates, one of the objectives is to reduce the amount of intermediation in the banking system to make loans more expensive and somehow contract the volume of lending and that will help cool off the economy. That’s one of the desired effects. But one of the unintended consequences that it generates is sharp losses on the portfolio of long-term securities that banks are holding or other institutions and that can create some fragilities for these institutions going forward. There are two observations here. The first one is, most of the advanced economies’ central banks have already indicated that they were close to the peak of their hiking cycle. And we look at the dot plots by the Federal Reserve, their own projections of where they expect to be over the course of the next few years… They’re indicating that they are close to their peak.
Also, banks are likely to be a little bit more prudent in extending loans. What that is going to do is that it will slow down the economy on its own in the sense it’s going to do the job of the central banks. So, less hikes may be needed even if inflation is a little bit more persistent. We are on this sort of knife edge between the additional cool-off from the contraction in lending and maybe, little still, some persistence in inflation.
What is your view on moves towards ‘dedollarisation’? India, for example, is entering into arrangements for rupee trade.
By and large, what we’re seeing right now is not making much of a difference to the international monetary system the way it’s organised. We live in a dollar world. At the level of individual countries, to facilitate trade with specific partners, it makes perfect sense to have arrangements that rely on local currencies that would not involve the dollar if it’s in the interest of all the parties. It’s not probably going to change the overall architecture because the dominance of the dollar rests on several interlocking features that involve not just trade invoicing, but also the currency in which you borrow. We’re talking about dollar debt. The currency against which you know central banks want to measure the movements of their own currency. Eventually, maybe, in the long term, we will have a more balanced world that will have more reserve currencies than just the US dollar. But this is not in the near or even medium-term future.