While inflation forecasts, which reveal ‘a more diffusive’ scenario, have been revised in the US, expectations remain little changed in most other economies, including India
The country’s apex bank pruned the policy rate by which it lends to banks by a full one per percent in three swift successions since February this year with a qualifier that henceforth the RBI would be data-driven and would rely on an emerging outlook for continued easing. Industry and trade cheered the news with enthusiasm, hoping it would ensure that credit remains available in ample amounts and at affordable rates. This was in consonance with central banks around the world cutting interest rates as the worst price upsurge in a generation contributing to the cost of living crisis appears to subside.
But even as the euphoria in the wake of policy rate cuts gets embedded into the economy to kick off a virtual cycle of growth and unleashing entrepreneurial élan, the Basel-based Bank for International Settlements (BIS), dubbed the central bankers’ central bank, sounded the siren of caution over the threat of renewed outbreaks and recrudescence of the demon inflation the world over.
In its comprehensive annual report with Annual Economic Outlook (AEO) released at the end of June, the BIS found that households in 29 advanced and emerging market economies expected inflation over the next twelve months to be about 8 per cent—far higher than the extant 2.4 per cent average inflation level. The BIS General Manager Agustin Carstens cautioned at the annual general meeting that “households, in particular, may show less tolerance for price increases and real wage decline following the sharp rise in living costs after the pandemic” and sought “if evidence of de-anchoring emerges, central banks must respond quickly and forcefully to inflationary shocks”. Inflation forecasts in this context reveal “a more diffusive” scenario. While they have been revised up in the US, inflation expectations remain little changed in most other economies, including India.
Stating that the world economy is at a crossroads, the BIS said sans much ado that “a sense of apprehension hangs in the air with long-established trade relationships beginning to fray as a wave of larger-than-expected tariff announcements in early April hit the global economy”. This is supervening at a time when the global economy was already wrestling with structurally low productivity growth, persistently weak fiscal positions and the build-up of large and often opaque non-bank financial positions. This is on top of rapid and disruptive technological changes posing significant challenges of their own.
Rightly foreseeing the wayward manner of the Trump Administration in doing damage to the global economy, the BIS said that even when tariffs are likely to be at levels “unseen in decades”, after the Liberation Day declaration of on-off tariff hikes by the US administration, “exerting a significant impact on both output and inflation in the following months”. Pointing out that the imposition of broad-based tariffs signifies further steps towards greater trade fragmentation, the BIS hoisted the red flag that these tariffs could further “accentuate the decline in productivity growth as supply chains come under further pressure. An ageing population and less migration will reduce supply capacity. The Phillips curve could become steeper, meaning that inflation could rear its head even with moderate increases in activity.”
The report highlights how trade restrictions in advanced countries hinder foreign direct investment (FDI), a stark reality that is happening to India in recent years, and reduce economic growth in emerging market economies (EMEs). Data on trade restrictions between 2009 and 2023 show that the total number of newly implemented import restrictions of advanced economies (AEs) on EME goods and services grew by an average of eight per cent per year. These new restrictions encompassed an increasingly larger share of imported goods from EMEs, rising from an average of about five per cent of total imports in 2009 to 62 per cent in 2023, a biting reality our trade policymakers need to reckon with. As coverage of trade restrictions expanded, annual growth of outward FDI by AEs imposing new barriers declined. AEs that had more than 50 per cent growth of imports from EMEs covered by trade restrictions saw much slower outward FDI growth to EMEs than those without trade restrictions. As such, the report point-blank noted that with FDI flowing at a slower rate to EMEs from “increasingly protectionist” AEs, the prospects for strong economic growth in EMEs have “deteriorated”, a dim and grim prospect for India as it aspires to soar on its much-touted merchandise goods and services trade.
EMEs that received a larger share of inward FDI from countries imposing trade restrictions on at least 50 per cent of their imports experienced slower average GDP growth. This evidence suggests, as the BIS report averred, that as trade protectionism continues to escalate, as it is happening in most advanced economies in trade reprisal sort of tariff hikes, less FDI will flow from AEs to EMEs, reducing the latter’s growth potential and worsening the prospects for economic convergence between advanced (AEs) and developing (EMEs) countries going forward, a fraught and frightening proposition. As such, the BIS pitches for “a reconfiguration of global trade towards less protectionist countries could reverse this trend, increasing FDI flows to EMEs and supporting stronger growth”, a goal devoutly desired for the sake of universal development and the summum bonum of humanity.
(G Srinivasan is a senior economic journalist based in New Delhi)
