From UPSC perspective, the following things are important :
Prelims level : Impact of capital outflwow
Mains level : Paper 3- Growth recovery challenges
The global economy was well on its path to recovery until the invasion of Ukraine by Russia.
Uncertainties in global growth prospects
- Divergent economic recoveries: Economic prospects have worsened since the Ukraine crisis, worsening the divergence between the economic recoveries of advanced economies and those of the developing ones.
- The prevailing uncertainties in global growth prospects come in the aftermath of frequent disruptions to worldwide supply chains in the last two years.
- Against this background, two key macroeconomic variables have a persistent effect on growth rebound.
- 1] Price pressure: There is tenacious price pressure, leading to policy trade-offs especially in developing economies.
- 2] Capital outflow: There have been capital outflows and a tightening of financial conditions, affecting investment and growth in the medium and long term.
1] Price pressure
- Global concern: In some of the advanced economies, inflation has reached its highest level in the last 40 years.
- The major contributors to high inflation are energy and food prices.
- A spike in oil and gas prices due to a tight fossil fuel supply and geopolitical uncertainty have led to substantial increases in energy costs worldwide.
- In developing economies, rising food prices have had cascading effects, culminating in higher overall inflation.
- This gets intensified if poor weather hits harvests and rising oil prices drive up the cost of producing and transporting fertilizers.
- In developing economies, higher prices for food impacts different sections of the population differently, depending on the types of food consumed and the share of food expenditure in a household’s consumption basket.
- Persistent short supply and increases in food and fuel prices could significantly increase the risk of social unrest as the poorer sections are pushed to the edge of heightened deprivation.
2] Capital outflow
- Emerging markets suffered their first portfolio outflows in a year in March 2022.
- The Institute of International Finance (IIF) says “foreign net portfolio outflows for emerging markets came to $9.8 billion in March.
- Investors have become more selective, as higher risk sensitivity mounts due to tighter monetary conditions and rising inflation.
- Reasons for capital outflow: Interest rates tightening in the United States is associated with capital flow reversals from emerging markets.
- Impact on developing economies: For developing economies, the result of sudden large capital outflows is currency depreciation and tighter external sector conditions, leading to growth fluctuations.
- Monitor the pass-through of international prices: Though the factors contributing to high inflation (global supply shocks) are beyond the control of central banks, they need to carefully monitor the pass-through of rising international prices to domestic inflation to calibrate their responses.
- Calibrate the pace of policy tightening: The pace of policy tightening needs to be attuned to prevailing economic situations and activity levels.
- Communicate the importance of inflation targeting: Central banks could also signal a readiness to shift the monetary stance to maintain the credibility of their inflation-targeting frameworks by clearly communicating the importance of inflation stabilisation in their objectives and backing it with policy actions.
- Foreign exchange interventions: As sudden capital flow reversals can threaten financial stability, foreign exchange interventions could address market imbalances.
- Fiscal consolidation: There exists an imperative to prune expenditure and get back to the road of fiscal consolidation.
- However, a push for consolidation should not prevent governments from prioritising spending to protect and help vulnerable populations affected by price increases and the pandemic.
- Income support policies: In the post-pandemic global economy, there will be a likely cross-sectoral labour reallocation.
- These transitions require labour market and income support policies that are designed to provide safety nets for workers without hindering employment growth.
The message from the current phase of global growth is clear. Policymakers in the developing economies have to prepare for tighter financial conditions and spillovers from geopolitical volatility.