The world economy, as per the World Bank, is staring at a ‘lost decade.’ Can policy interventions help recoup some ground when new challenges are cropping up?
The last time the world had a lost decade–or at least large parts of the world lost a decade of development–was in the 1980s. Three, four things that happened then are like what’s happening now. One of them was oil price hikes. Then we started to get interest rate hikes in the US; they were faster and greater than what we’ve seen now. This left a trail of developing countries bankrupt because the cost of borrowing went up. That’s what we worry about today since we are starting to see the same sort of things. Growth is slow and we have high inflation. As a result, monetary policy must become progressively tighter. While the interest rate hikes are not as big this time around, we don’t have fiscal policy instruments because many countries, especially the advanced economies, spent a lot during the pandemic.
What about India…
Fortunately for India, we are going to have solid economic growth. But it will not be nearly as solid as we might have expected if global conditions were more like what they were in the early 2000s. Countries like India did better fiscally (during the pandemic). Many emerging market economies like India didn’t spend a whole lot though there were pressures on the finance minister to spend more. I think she did well to not overspend. As a result, we now have a stable fiscal situation.
The developed world banking crisis looks contained for now, but can further rise in interest rates cause another turbulence and will there be a spillover impact on the emerging world?
The answer is yes and yes. These things are hard to forecast. For example, if you go back to the time of the global financial crisis, we had bank failures interspersed by periods of optimism. Bear Stearns failed, then things looked contained for nearly 12 months, and then Lehman happened. Sometimes it takes a while for something that might seem to be an isolated banking crisis to turn into something more generalized. I don’t think we can rule that out. If that happens, I don’t believe there will be serious financial contagion to countries like India. But there will be economic contagion; in the sense that slower growth in the world will affect every economy—even well-managed ones. While this is unlikely, you can’t rule out the likelihood of a global recession. Global recession, by the way, is if global GDP growth falls below 1 percent. The world economy is skirting pretty close to that edge. And if you have something like that, then it’s going to be very hard for India to not be affected. If you have isolated bank failures, I don’t think that’s a danger to India. But if it’s a generalised banking crisis, then that could lead to a global recession and a noticeable slowdown in India.
Inflation has emerged as a key challenge over the past few months. OPEC’s decision to cut output has made it tougher. How do you see the situation?
I think there is a tendency to over interpret each of these events. When China opened, there was this sudden euphoria. You started to see some things improving again, and started to see optimism. Then you had these bank failures and suddenly, pessimism returned. Then we thought that these financial risks are contained, and expectations started to moderate again. Most recently, we have this news about OPEC plus cutting production and the world starts to go into a funk. I think people are overinterpreting this too, perhaps because they were building in lower commodity prices into their forecasts and suddenly, they went up. I don’t think we should pay too much attention to each of these events. It would be better to see what’s happening behind these economic gyrations. So, what’s happening to GDP growth in advanced economies? What is happening to potential growth in emerging markets? And, when you do this, it’s not an encouraging picture.
Look at growth in the big emerging economies. There is a rebound for China, which will go from about 3% growth last year, which was one of its lowest growth performances in a few decades, to something more normal in a rebound; closer to 5%. But China’s growth is masking a general decline in emerging market growth rates, which will decline if you exclude China. So, one must look beyond these sorts of one-off events. This is what worries us a lot more. At the World Bank, we have just finished a detailed report on potential growth across the world—in advanced economies, in middle-income countries, and in low-income countries. It’s called “Falling Long-Term Growth Prospects”—nothing subtle about the title, and it should get everyone worried. Whichever way you look at it, you find potential growth rates are going down compared to the first decade of this millennium. There’s less work, there’s less investment and there’s less trade. And if you have less of those three things, there’s no other outcome than slower economic growth, unless governments do something about it soon.
Are we done with interest rate increases?
Essentially, tighter monetary policy is trying to make real interest rates positive. If you examine real interest rates, you find three different trends. The first is that in the case of countries like India, real interest rates were positive even before these hikes and they’ve gone up over the last year. In the case of the US, real interest rates were negative before these hikes, and now they are positive but still low. In the case of the Euro area, they were negative before and they are still negative. So, we should expect to see higher interest rates in Europe, more so than in the US. Countries like India and Indonesia and others were quicker to respond to inflationary pressures compared to the Fed and the European Central Bank. They are not playing catch-up now. What they are doing is that they are responding to the pressures that are coming their way; because the US Fed is playing catch up and the European Central Bank is playing catch up.
You spoke about potential growth. What can the world do to lift it amid multifarious challenges at this juncture including geopolitics and climate change?
I’ll start with the things that could make it worse. Financial crises make matters worse, and the effects of a financial crisis last for the next 5 years. It is obvious that the first thing you must do is avoid a financial crisis. Central banks must walk this narrow path between trying to keep inflation down and being careful you don’t risk a financial crisis on the other side. The second one is supply disruptions, like war. If the war spreads or if it becomes worse, all these bets are off. We must prioritise a quick end to the war in Europe. The third thing is pandemics and lockdowns. Those are shocks that one has to manage and manage them right as compared to the last time. I don’t think we managed things well the last time; developing countries copycatted richer countries, without the public finances and private markets advanced economies had.
I don’t think there’s a quick fix to this, but there are fixes that actually can work over 2-4 years. The first is that in the parts of the world where you still have a lot of poverty, sub-Saharan Africa, or where you have serious employment problems, like the Middle East, Africa, and South Asia, you also have pools of human capital that are not being utilised. In general, female labour force participation in these places is low and somewhat stagnant. We have been much better at educating girls than encouraging women to participate more fully in the economy. But it does not have to be this way. We publish an annual report called “Women, Business and the Law” and it details what can be done in countries like Turkey, India and Jordan. The recent experience in Saudi Arabia shows that you can improve these conditions quickly. Of course, you also need a robust economy, but some of these countries—most notably India, already have a robust economy.
The second one is that we must increase investment. Over the last three years, the investment climate has deteriorated because policymakers have stopped prioritising things like pro-business reforms. A lot of countries slowed down on that because they were doing other things, for very understandable reasons. But now one must get back to making conditions for business better and ask how we can most quickly prioritise private investment. An important part of the greater investment is predictability in fiscal policy, predictability in monetary policy, and so on. But there is more. We are working on a new report that measures the “business readiness” of 180 countries: we call it the Business Ready Report, or B-Ready.
The third thing is to recognize that China is not going to be growing at 10% a year as it did in the early 2000s. It is going to be growing at less than half of that. It will be difficult for any other economy—even one as large and dynamic like India’s—to emulate that performance. But if we do a few things right, the global economy can recreate China in the aggregate. A big part of that is going to be India, but India is not going to be all of it. But imagine if India gets an extra one percentage point; Indonesia, which is doing well, gets another; Bangladesh gets it, Vietnam gets it, and Brazil and Mexico get it. A worldwide change in growth rates to bring you back the same potential growth rates that we had 10-15 years back. For that, you need one more thing: international trade. If we don’t revive international trade, then you will not get this. Governments in the developing world should be giving the World Trade Organization a lot of support. So again, what every country needs is more work and more investment; but what will make it happen across the world is more trade.
You said India could be one of the countries that could provide that kind of growth. Can the existing policy framework support it? Also, one is hearing of ‘nearshoring’, ‘friend-shoring’ and emphasis on shifting supply chains. Can this really infuse efficiency and help global growth?
We don’t really worry about India these days. India doesn’t figure much in the international press. That’s a wonderful thing because generally when a country figures prominently in the international press, it’s usually not for a good thing. India is growing already at 6% and the questions are about how it can get to 8% or something near.
On your point about trade fragmentation, friend shoring, nearshoring etc., we must think about it in more simple terms, like China plus one. It’s not so much a political problem as it is a diversification problem, because the world doesn’t want to put all its eggs in the China basket. It’s not as if China won’t participate in these value chains. Policy makers just want some redundancy built in, to the extent that things that have happened over the last few years don’t happen again. In many things China plus one, equals India. You do find that there are lots of things that India could be taking advantage of, and India is taking advantage of. I’m so impressed by what Apple India has been doing, for example. You could question the pace of these changes in other parts of the Indian economy, you could say that we could be doing a lot more. We should be attracting a heck of a lot more rather than just iPhones and a few other things. But here one must sort of look not just at union government policies, but also state government policies. At this stage what I would really like to see in India is some states starting to do big and bold things about issues on the concurrent list — labour reforms, land reforms. Many of the things that India needs to do now are not on the Union list and not entirely on the state list, they are on the concurrent list.
There is a big push from the government for capex in India. But private sector investment is yet to catch up. What do you think is holding it?
That’s not just an India thing, that’s everywhere. I think we have expectations of the private sector that are too high. We want the private sector to be working on problems that are of public interest rather than private profit. I don’t think India is doing badly on this score. Those are the kinds of discussions that we have here in Washington all the time: how we can get much more private-sector participation in matters of public interest. You have options like public-private partnerships, loan syndication and green bonds. The evidence on all this is not particularly encouraging in other parts of the world, and India might actually be doing better than most. I would keep expectations modest, even in the case of India.
In terms of its trade engagement, how do you see the shift in India’s approach? Focus has now turned to trade agreements with large economic entities like the US and EU.
There is a very good report coming out soon from our India team called the Country Economic Memorandum and that answers questions like the one that you are asking. The general answer I would give is that India has been a little too passive about globalization. We think that the rules of globalization should be made somewhere else. But India is no longer a small economy. India has the G20 Presidency right now but, even if it didn’t, India is an influential country. India has credibility in both camps, the ones that we are talking about, the ones that might threaten globalisation. I think that India should be much more active in setting the rules of globalization.
There are apprehensions that the US may slip into recession later this year. Is that a cost that must be paid for inflation or is it time to really pause monetary measures?
The last time that we ran our numbers we did not think that the US would go into recession. We thought that the US would narrowly avoid a recession. If it does not, that is what is called a “hard landing,” in which you must start to shrink economic activity to cut inflation rates. But that has dangers of its own. Once you start to shrink economic activity, you increase the likelihood of businesses failing, which means that the banks that have loaned money to these businesses then will also get into trouble. We do not like to think about such scenarios just yet, because there are too many other problems already.
