World Caught Between Soaring Inflation and Debt

Emerging out of the Covid-19 pandemic, global economic recovery is proving to be a tricky business, requiring a delicate balancing act by governments and central banks. This is because most of the world has racked up huge amounts of debt, while trying to stimulate their economies, in addition to the debt they already had. Western economies, in particular, pumped in huge monetary and fiscal stimuli, to maintain high liquidity conditions as well as to protect jobs or provide unemployment benefits. In many cases, the spending was of such magnitude as to push advanced countries’ fiscal deficits into double digits. According to the IMF, global debt soared by US $ 28 trillion in 2020 alone, to reach US $ 226 trillion.

In an unprecedented situation such as a global pandemic, this volume of government spending, it was felt, was necessary. Not to mention all the spending on healthcare costs and providing vaccinations to populations all over the world.

In emerging and developing economies, the pandemic has unfolded in a slightly different manner. China – if one can call it an emerging and developing economy anymore – was the first to recover from the pandemic thanks to their strict lockdown of Wuhan province and provided an impetus to global growth. This is why I have always stressed the importance of China’s economic growth to the global economy’s growth. Despite the trade war and the high tariffs that continue to be in place between China and the US, global trade began to recover. The immediate effect, as always, could be felt in commodity prices which began to soar by the third quarter of 2020 itself.

What growth China catalysed, was then followed by economic recovery in Western economies as they speeded up vaccinations and were back in business. While much of this boost to commodity demand and prices would have been good news for commodity exporting countries which make up a considerable part of the developing world, it was always going to be volatile, depending on how the pandemic panned out. Still, many developing and emerging economies would have experienced a reasonably good economic growth – not least, also because of a base effect – based on commodity exports as well as good capital inflows from advanced countries.

In the case of India too which is not a very big commodity exporting country, our exports did exceedingly well between 2020 and 2021. And capital inflows too were aplenty, with stock markets soaring to new record highs during the pandemic. Much of the latter was, of course, due to excess money pumped in by central banks all over the world that was in search of better yields and growth. Our government took the decision to pump-prime the economy through public spending on infrastructure, as well as measures to help MSMEs manage to stay afloat during the pandemic. We have experienced reasonably good economic growth so far, largely due to a base effect, and good corporate earnings. However, the services sector still continues to be battered and that is around 55% of our economy. Besides, consumption demand which was weak even before the pandemic showed a brief revival thanks to pent-up demand after the lockdowns of 2020, but have not even regained pre-pandemic levels yet.

Yet, there is raging inflation. Not in India alone, but across the world in varying degrees and for various reasons. Some of it is due to supply shortages as the world adjusts to surging demand for certain goods, while some is due to a hike in wages and the start of a wage-price spiral, especially in western economies. The biggest dangers facing emerging and developing economies in 2022 and 2023 are the state of the Covid-19 pandemic and the type of economic recovery.

The biggest factor looming large is the tightening of monetary policy by the US Federal Reserve in the US, as it has implications for the entire world, thanks to globalized finance as well as its effect on commodity prices. The Federal Reserve has already initiated a reduced bond-buying programme which was to end in June and was then hastened to end in March this year. On top of this, it is expected to raise interest rates from near-zero levels, in order to combat inflation in the US which was 7.5% in January, year on year. The Bank of England has already increased rates twice this year to 0.5% as inflation in the UK is at 5.1% and the ECB (European Central Bank) is expected to follow soon.

In India, the RBI has staved off interest rate decisions until now, but it too will have to act soon as inflation has been high and stubborn for many months now. In India’s case, a lot of it is due to high oil prices, though this government has inexplicably persisted with high excise and import duties on crude oil ever since it came to power. Not surprisingly, it is finally telling on transportation costs and on all product prices. Some of it is also due to supply shortages of chips and other inputs which have also put an upward pressure on prices. And core inflation is stubborn at 6.1% since last year.

The need for RBI to act is even more accentuated by the government’s budget this year, which is government capex led and about which I wrote recently. However, RBI’s rate increase will adversely impact the government’s huge borrowing programme, and bond prices have already indicated their concern with the massive borrowing and large fiscal deficit target for FY23.

As a result of the US and western economies hiking rates, much of the foreign capital inflows into emerging and developing economies is likely to return to the advanced countries. Countries in Asia and Latin America are most prone to this kind of capital flow reversal, and private investment is likely to get dampened. Worse, with the increase in interest rates in US and much of the western world, their economic growth is also likely to slow to more moderate levels – accentuated by a reversal of base effect – which means less demand for products from emerging and developing countries. Commodity exporting countries will be the most impacted by these developments over the coming year. Foreign investment and trade, therefore, are likely to be more muted in 2022 and possibly through 2023.

Strangely though, through all of the rapid recovery from the pandemic, China is one large economy that seems to have escaped high inflation. Consumer price inflation of 1.5% is something most countries would die for. That could be because their economic growth through much of 2021 was led by healthy exports which are no doubt, slowing down now. The Chinese economy has also been badly hit by the Evergrande real estate crisis as well as a more general crackdown on certain tech industries. As exports start to slow, China too will have to undertake expansionary policies and hopefully this time, they will be focused on boosting consumer demand at home.

With most emerging and developing economies dependent on exports, especially to the Chinese market, it would help that the Chinese grow their domestic economy through broad-based recovery – consumption, investment and exports. And with the world still reeling under massive amounts of debt, it helps if there are a few engines of growth across the world. With most countries unable to increase taxes at a time like this, and with consumption-led demand slowing, emerging and developing economies will have to rely on more private investment as well as exports.

The Asian tiger economies can certainly look at greater private investment (both local as well as foreign) especially in sectors which are plagued by supply shortages. For example, there is no doubt that chips will be required in ever greater numbers not merely during the cyclical upturn, but well into the decades ahead and it is an industry that needs more investment, both in R&D as well as in production. The problem is that a few Asian countries already dominate this industry, so how can we distribute the investment in semi-conductors more broadly even within the region?

Clean and renewable energy is another area that is crying out for new investment, and it has been attracting a lot of investment in recent years. Can we shift the focus of new investment into solar and wind energy, battery production, clean technology, hydrogen fuel cells, etc. These are clearly also the requirements under the commitments that countries have made toward mitigating climate change and reducing carbon emissions. And like semi-conductors, this too is an area that is long-term in nature and goes well beyond cyclical economic recovery.

What about investments in medical infrastructure in African countries to help them vaccinate more of their population more quickly? This too needs investment for the longer-term, although the immediate effects of it would be to fight the current pandemic and any more variants of Covid-19. After Africa’s experience with Aids and Ebola, it should be quite apparent that the continent needs to boost its medical infrastructure with international know-how and investment for the entire world to strengthen its health defence system. This would require more than a financial investment; it needs technical know-how as well as cooperation with local African governments.

Another promising area for future investment is in helping Africa shift to manufacturing from agriculture and commodity exports. Surely, the world needs more manufacturing centres that are close to abundant raw material supply as well as low labour costs, relatively speaking. This would help create millions of jobs in Africa and help them modernize and grow their economies, as I have written before. Of course, the terms need to be less exploitative and more mutually beneficial to all concerned.

These are just some of the ways the world can help generate more revenue and growth in the next few years as we emerge from the pandemic-induced global crisis. The levels of government debt are staggering and it is incumbent upon multilateral financial institutions to agree on more relaxed repayment terms that are realistic and achievable. I haven’t yet read the details of IMF’s policy discussion paper on advanced countries lending their SDRs to poor and low-income countries to help them manage their debt better, but on principle it does sound like a good idea.

Yes, the world is caught between high inflation and even higher debt for the next few years. But with a little imagination, better use of the world’s wealth (so much of which was generated during one of the worst crises to hit all of humanity), and most importantly with greater cooperation, there are a few avenues for growth out of this crisis.

It is for the G20 to take this forward, and for the world to walk together.

The animated owl gif that forms the featured image and title of the Owleye column is by animatedimages.org and I am thankful to them.  

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