For nearly two years, governments and central bankers in the developed world played Santa, dropping money down the chimneys of economies to prop incomes, defend demand and keep financial markets afloat. In an ironic turn of events, in the season of Christmas when carols call for decking ‘the halls with boughs of holly’, money managers of the world have chosen to wrench the punch bowl off the table.
The many theories of economics hang between assumptions and expectations. The question haunting folks is whether the slide symbolises alarm bells about the future state of the global economy or is just a hangover of the intoxicating effect of easy money.
Effectively, the thesis of ‘free market pricing’ was in suspended animation as central banks bought trillions of dollars of private and public debt whether kosher or junk. Easy money fuelled a spiral in asset price valuations whether homes, crypto, stocks or commodities and triggered record high inflation across the world.
Inflation, particularly higher fuel and food prices, propelled public outrage ending the regime of ambivalence couched in definitions. This week, the US Federal Reserve effected the much-talked about pivot, doubling the pace of tapering bond purchases, the European Central Bank cut down pandemic emergency bond purchases and the Bank of England hiked interest rates signalling the end of what bankers call “accommodative stance”.
The red in the festoons splattered on indices across stock markets — from Nikkei to Nifty to NASDAQ. Between Monday and Friday, the US benchmark indices DJIA and S&P 500 dropped over 1.5 per cent and NASDAQ slid nearly 3 per cent. In India, the BSE Sensex slid over 1770 points or 3.02 per cent and the Nifty over 500 points or 3 per cent.
Curiously in the immediate wake of the US Fed decision, markets rose in unison, almost as if in applause. Typically, the day after catalysed questions on the trajectory as savers and markets parsed the signal from the noise. Essentially, the dot map of US Fed (which is FOMC members indicating their views) signals three rate hikes in 2022 and four in 2023 taking US interest rates to 1.75 per cent — higher than before but still negative in real terms, that is lower than the rate of the level of inflation, and much lower than expected yields from stocks.
What is significant is on Friday, the 10 year US Treasury yield was quoting at 1.41 per cent – lower than where it was before the ‘pivot’ and much lower than the March 2021 peak of 1.73 per cent. Pundits reckon that the uptick will be limited to the short term. Effectively, the market isn’t buying into the cohabitation of growth and inflation theory. The long and variable effect of monetary policy could well turn out to be the dreaded long rope!
Context is critical for policy design and determination of outcomes. The fundamental question is whether the promised/proposed increase in interest rate, rather negative real interest rate can tackle the phantom of inflation? Critically, one of the principal causes of inflation is the disruptions in supply chain and easing this depends less on interest rate and more on how the world engineers policy to enable economic engagement amidst the pandemic.
Arguably, the Omicron variant is less lethal even if more transmissible. The question though is not whether it is less lethal or more transmissible but whether it leads to shutdowns and disruption. The circumstance of the rising number of cases in France and the UK and fears expressed in Churchill’s terms of ‘tidal wave’ raise the spectre of lockdowns. Mind you, the Delta variant is still dominant in parts of the world. And globally pandemic management is governed by what is defined as ‘recency effect’.
The fundamental question, therefore, is whether the forecasts of growth in 2022 will survive in an income and cost sensitive environment as interest rates rise. Will deferred consumer demand survive costs or die in detention? Small and medium enterprises have witnessed savage destruction of capital and capacity. Will they survive and sustain livelihoods under the new rate regime?
The angst and anxiety reflected in financial markets are rooted in questions about the real economy. Central bankers have to work with backward looking data to formulate forward looking policies while consumers collate emotion and logic to determine their outlook. To paraphrase a line from the song from Amar Akbar Anthony, you could say “the coefficient of the linear is just a position” between institutional inadequacies and what individuals experience.
The dilemmas erected by developed economies are already denting and detaining prospects of emerging economies. There is the issue of rising cost of servicing debt on national balance sheets and the impact of the erosion of currency. Already, the effect is visible in portfolio inflows and exchange rates.
The India Story is placed bang in the centre of the debate. It is imperative that Budget 2022 be leveraged to incentivise states to propel reforms and liberate the factors of productivity, particularly land and capital which are hostage to rent politics. Finally, India can scarcely afford to be distracted by politics and lose the economic momentum witnessed in recent months.