Literature is dotted with adages about the fallibility of popular notions. As Daniel Kahneman observed, “We are blind to our blindness. We have very little idea of how little we know. We’re not designed to know how little we know.”
Received wisdom, though, has not deterred bullish punters in stock markets from believing what they chose to believe – that a slowdown and social cost of rate hikes would result in a pivot and rate cuts in 2023. This fuelled the rise of S&P 500 by 17.4 per cent in just 41 days between June and August. Markets elsewhere followed suit – for instance, in India, the Nifty 50 mirrored the rise from 15,293 to 17,956.
On Friday morning, US Federal Chairman Jerome Powell virtually read out the riot act. At the Jackson Hole Economic Symposium, Powell declared the US Fed would continue taking forceful and rapid steps “to keep inflation expectations anchored.” Citing the Paul Volcker dictum “inflation feeds in part on itself”, Powell deflated all talk of an early pause stating, “We will keep at it until we are confident the job is done”. What’s more, projections of the median Fed rate will be updated.
Critically, in his eight-minute speech, Powell chose to mention inflation 47 times, growth thrice and unemployment only once – and admitted that rate actions would cause pain to households and businesses. The message was clear to those who bet against the Fed. By the end of the day, the S&P slid by 3.07 per cent with only five stocks in the green, the tech-heavy NASDAQ by 3.7 per cent and Dow Jones by over 1000 points.
The sell-off has implications for the global economy in general and the India Story in particular. Effectively, as the US Fed hikes rates from 2.3 to 4 per cent, withdraws nearly a trillion dollars in quantitative tightening and marinates the economy at a higher rate, the global cost of capital will rise. What happens on Liberty Street and Wall Street is not limited by geography.
The global quantitative tightening of financial conditions will impact India. For starters, the RBI would need to respond by hiking repo rates beyond levels previously envisaged –impacting consumption, investment and growth – to protect the currency. Rising rates will also inform and influence capital flows to emerging economies like India – into debt and equity, and private equity flows into start-ups.
The slide in stock markets also represents the fear of possible slowdown and recession. There is much lather about the possibility of a soft landing but as the cliché on Wall Street goes, the last successful soft landing was by Chesley ‘Sully’ Sullenberger when he landed an A320 on the Hudson. Already Europe and the UK are heading into recession, Japan has slashed GDP estimates, and the US has seen two-quarters of contraction. Between them, these economies account for over $40 trillion of global GDP – and this has the potential to exacerbate the recent fall in India’s exports and the widening of the current account deficit.
On Friday, the dollar index touched 108.80 - over 13 per cent higher than it was at the beginning of the year. The rise of the dollar index illustrates the spectre of inflation and falling growth. Typically fear has no bottom, and this drives the flight of capital to the dollar. Historically, global growth has been higher when the index is lower. The rise in the dollar index leads to outflows as seen in India, depreciation in currencies causes spikes in import inflation and affects GDP growth.
A few weeks earlier, this column had cautioned that the world would need to brace for impact as central banks are flying blind. The past is not necessarily the prologue of the future, and a confluence of disruptions has upended the architecture of the global economy. Agustin Carstens, chief of the Bank of International Settlements, explained this eloquently at Jackson Hole. In the past, before the pandemic, tailwinds including technology, geopolitics, globalisation and demographics enabled supply to respond to demand. The pandemic and the war revealed supply side fault lines, and Carstens warned that “in the coming years, many of the disinflationary tailwinds are set to turn into headwinds.”
Policy in a political economy is influenced both by rational inattention and irrational attention. It is true that India is the fastest growing large economy. Equally, GDP estimates and forecasts are not static and are subject to circumstances and limitations – the 7-plus per cent growth is not cast in stone. The pace of growth and the scale of its domestic economy amplify India’s potential to harness portfolio flows and investments in the race for resilience via near-shoring or friend-shoring of supply chains.
Growth and prosperity, though, are not ordained and require momentum on the policy front – from accelerating privatisation and monetisation of assets for resources to reforming land and labour laws to unclogging regulatory cholesterol – to enable investment and growth.
The change will require Team India, the Centre and the States, to work in sync. The trillion-dollar question is whether the political class of the world’s largest democracy will take a break from rhetoric and drive policies to convert the challenge into an opportunity.
Author of The Gated Republic, Aadhaar: A Biometric History of India’s 12 Digit Revolution, and Accidental India