India’s economy is gaining strength, though the recovery is uneven and walking through soft spots, amid rising global risks, according to an article in the Reserve Bank of India’s latest monthly bulletin.
Increased vaccination, decline in new cases/mortality rates, and normalization of mobility have rebuild confidence, according to the State of the Economy article.
Domestic demand is gaining strength while overall supply conditions recover, supported by the strong performance of agricultural production in the fall and a recovery in manufacturing and services.
“Lighter than expected, food prices have eased headline inflation into closer alignment with the target,” said a group of 20 RBI officials led by RBI Deputy Governor MD Batra.
Looking ahead from here, the main downside to India’s economic outlook, aside from the pandemic, is the potential for a sudden exacerbation of global risks, officials warned.
Normalization risk as activity loses momentum
As pent-up demand collides with shortage of supply, price pressures push policy authorities to scale back stimuli.
“However, with the global recovery easing recently, there is a risk that fiscal and monetary policies will return to normal just as activity loses momentum,” the authors said.
Moreover, the global economy may have to deal with new waves of the pandemic and simultaneously withdrawing stimulus.
The authors opined that: “Everywhere, increased demand is being stifled by supply bottlenecks, jeopardizing the global recovery.
“In fact, supply chain disruptions seem to feed on each other, amplified simultaneously by decarbonization campaigns and trade wars.”
Officials emphasized that a global labor shortage is hampering factory production and delaying vital services such as transportation as people choose to withdraw from the workforce.
They note that as margins shrink and prices rise, high levels of inflation combined with significant heterogeneity across the country reflect these supply and demand imbalances and intense competition between countries for natural resources and key intermediaries – most recently energy.
These developments are forcing the hands of central banks and financial authorities to reduce their epidemic policies, led by emerging economies, and this is forming in other headwinds for global growth.
The authors note a consensus that appears to skew around speculating that supply gaps and impediments will persist at least through the better part of 2022.
“The fear is that in between the thrones, the effects of the second round could emerge, cementing inflation while growth stagnates. There is also the possibility of experiencing a stock slump when the supply buildup is eventually unleashed, they said.
According to the article, there is an urgent need now about accelerating global vaccination, but in these evolving configurations, it is becoming increasingly clear that vaccination alone will not boost the global economy.
“Other factors at work must be addressed with the right mix of policies and cross-border coordination to keep the recovery going.
Warning signals from the financial markets
“Financial markets are already sending warning signals – stock prices are volatile, fearful of rising bond yields, and currencies withering in the face of a stronger US dollar,” the report’s authors said.
Officials emphasized that markets fear that the inevitable rise in interest rates will be driven by rising inflation rather than by higher growth.
They suggested: “…the need at present may not be to focus singly on normalization but on supply-side reforms to ease bottlenecks, disruptions, labor shortages and higher commodity prices, especially crude oil.”
The article said the focus would likely be on normalizing prudential policies and strengthening insolvency frameworks and restructuring mechanisms, including the burden of public and private debt.
The authors stated that: “In particular, the choice of policy mix will need careful and sensitive consideration as employment is expected to affect the recovery, as people lose income and jobs, and those with jobs lose purchasing power.
“Already, employment prospects are shining ahead of the festivals, with entry-level hiring growing at the fastest pace.”