A global picture
The latest WEO figures for India spell bad news for the BJP
By: Bhaskar Dutta
The International Monetary Fund releases its World Economic Outlook twice every year. As its name suggests, the document contains the organization’s forecast about rates of growth of the world economy as well as predictions at a more disaggregated level for regions and major countries. Against the background of the single-handed efforts of President Donald Trump to destroy world trade, many people were quite pessimistic about the IMF’s short-term predictions for the world economy. The latest WEO, released only a few weeks ago, comes as a pleasant surprise.
The WEO predicts that the world economy will grow at an average rate of just under 4 per cent during 2018 and 2019. This will be quite a credible performance in view of the existing pattern of long-term growth rates over the last 20 years. It turns out that except for the four sunshine years between 2004 and 2008, the world economy has never touched a growth rate of 4 per cent since 1999. Of course, like most averages, this one too is an aggregate of varying growth in different regions. More specifically, the pace of expansion in the euro area, the United Kingdom and Japan is slackening, while it continues to be above the world average in the United States of America and several emerging economies, including India and China.
Given the current global environment, the WEO naturally contains a warning about potential dangers that can hit all the predictions about growth for a six. The most serious stumbling block to sustained world growth is, of course, the possibility of a full-scale global trade war. After the WEO was written, a trade war between the US and China has actually broken out, while the US and the European Union are at the negotiating table trying to avert a trade war on that front. The imposition of mutual tariff barriers in the two giant economies will inevitably raise costs of production since producers will now have to pay the higher tariffs on imported inputs. If the increased tariffs actually serve their intended purpose of promoting import substitution, then producers will have to go around searching for domestic suppliers and this can disrupt supply chains. Moreover, the uncertainty about whether the trade war will spread or how long it will last can result in the postponement of fresh investment projects resulting in slower growth.
The other major source of worry for the world economy has been the rising price of crude oil. Oil prices surged by almost 20 per cent between February and June. The OPEC countries then decided to supply more oil in June in order to regulate the market. This has provided some temporary relief. However, as I write this, reports of an unexpected depletion of US oil inventories have resulted in oil prices inching up again. While this is a bonanza for the few oil-exporting countries, the large number of oil-importing countries face mounting oil import bills, higher costs of production, particularly in oil-intensive lines of production, and a consequent dampening of growth.
The WEO does not include Brexit as one of the potential constraints on world growth, possibly dismissing it is a ‘local’ issue. This may be a significant omission. All indications are that this is going to be a messy divorce with Britain exiting from the EU with possibly no agreement about the future. There have been several forecasts about the damage to the British economy, with a 1 per cent slowdown in growth in the short run being somewhere in the middle of the range of estimates. All observers also emphasize that the EU economy will be severely damaged at least in the immediate future since there will be severe dislocations in supply chains. Since the EU and Britain have a significant weight in the world economy, a slowdown in these economies has an immediate direct effect on world growth. In addition, there will be indirect effects.
How does it all pan out for India? In my last column on July 2, I mentioned the assertion of the prime minister that the economy had grown at just under 8 per cent in the previous quarter and also ridiculed the claim of the interim finance minister that the economy could surge to a growth rate of 10 per cent for the fiscal year, 2018-19. These claims are all part of the long-term campaign for the 2019 general elections. Presumably, the IMF’s views are more balanced and pragmatic. The latest WEO figures for India spell bad news for the Bharatiya Janata Party. It forecasts that India will grow at 7.3 per cent in 2018 and 7.5 per cent in 2019. These numbers are actually slightly lower than the WEO’s earlier estimates contained in its April release and significantly lower than the numbers claimed by the government. The latest GDP growth figures seem to suggest that the prime minister’s claim is correct – the economy grew at just over 8 per cent in the last quarter.
However, there are reasons for the more pessimistic prediction. First, the effect of any increase in global oil prices is particularly adverse for India since it imports almost 80 per cent of its oil consumption. It is unlikely that the government will increase final prices at the pump with elections round the corner. So it will be forced to lower the various taxes it imposes on oil in order to compensate for the higher import price. Since oil revenue has been an important source of government revenue in recent times, this will accentuate the precarious state of government finances with its concomitant effects on public investment and, hence, growth.
Second, the current price situation in India is not very comfortable. Domestic prices have been rising in the last quarter. This caused the Monetary Policy Committee of the Reserve Bank of India to raise the repo rate during its June meeting – this was the first increase in the interest rate structure by the RBI during the reign of the current National Democratic Alliance government. The MPC met in early August and raised the repo rate again. The relatively high interest rate structure is not very conducive to fresh private sector investment. It also contributes to making Indian exports uncompetitive in global markets since the cost of raising working capital is higher in India.
Third, and somewhat paradoxically, the good health of the US economy also spells some danger to the Indian economy. The Federal Reserve boar has raised interest rates in the US and may do so again if it apprehends that the economy may overheat. The rising yield on corporate bonds in the US has resulted in a reverse flow of portfolio investment back to the country from Indian stock markets. The external value of the rupee has been falling steadily. While this may help Indian exports, imports – including crude oil – will be more expensive in India. The latter will obviously have an inflationary effect on the Indian economy. Much will depend on whether the RBI decides to adopt an aggressive policy to prevent any further slide in the external value of the rupee.