Can India escape the effects of a global recession?

Central banks around the globe have become hyperactive to control inflation. Late to act on the worst inflation in four decades, many central banks are now desperate to redeem themselves in fulfilment of one of their key tasks – to keep inflation under control.

About 90 central banks have hiked interest rates this year. Many have done so more than once. Ethan Harris, the Chief Economist of the Bank of America, has labelled the phenomenon as “a competition to see who can hike (the interest rate) faster.”

This is the broadest tightening of monetary policy globally in 15 years -- a stark contrast to the easy money era ushered in after the 2008 financial crisis and then during the Covid pandemic. In September, the US Federal Reserve hiked its key rate by 75 basis points for a third time this year. The Fed’s rate hike showed its commitment to bringing down inflation in the US, which is at a four-decade high of 8.5 per cent. To cut through the euphemisms, the Fed's rate hikes are intended to slow down an “overheated” US economy and to throw people out of work to put downward pressure on wages and inflation.

Economist Nouriel Roubini -- nicknamed ‘Dr Doom’ for correctly predicting the 2008 housing bubble crash -- sees a “long and ugly” recession occurring in the US and globally at the end of 2022 that could last till the end of 2023. He says that achieving a 2 per cent targeted inflation rate without a hard landing is going to be “mission impossible” for the US Federal Reserve.

There is now a 98 per cent chance of a global recession, according to Ned Davis Research data released in late September. The only other times that the recession model was this high were during severe economic downturns -- most recently during the 2020 pandemic and during the global financial crisis of 2008-9.

India is not immune to the US or global recession, though its economy was never fully coupled with the global economy. The domestic growth rate has slowed by 1.5-2.5 per cent even in normal Fed-led recessions. ‘Dr Doom’ predicts that this recession is going to be a long and ugly one, unlike any other shallow recession.

America’s share in India’s merchandise exports has increased to 18.1 per cent in FY2022 from 10.1 per cent in FY2011. The rise of the US market share in India’s export basket has obviously increased India’s vulnerability to a recession in the US economy. In FY2021, the US was the major destination for India's software exports, accounting for 54.8 per cent share. A US recession is bound to have a major adverse impact on India’s software exports, margins, and service sector jobs.

Fed rate hikes have already started impacting the Foreign Portfolio Investment (FPI) fund flows, forex reserves, and the Rupee. FPI outflows from Indian equities may not yet be over. As India's foreign exchange reserves declined for the ninth consecutive week, it dropped to the lowest since July 2020 to $532.66 billion, as per the Reserve Bank of India (RBI)'s weekly data released on October 7.

A declining Rupee is facing renewed pressure, as the Dollar continues to strengthen in the wake of the Fed's latest 75 basis points jumbo rate hike. Surging crude oil prices, expectations of continuing Fed rate hikes, and the widening current account deficit are pushing the Rupee to new lows. According to the brokerage house Motilal Oswal Financial Services, India’s current account deficit will likely widen to a decadal high of 3.8 per cent of GDP in 2022-23, from 1.2 per cent last year.

The RBI’s rate cycle may not be counter to the Fed's rate cycle and the rate hikes will obviously put pressure on India's growth. The RBI's monetary policy panel will have a tightrope walk to do as it tries to reconcile two contradictory goals -- to restore a semblance of price stability without choking growth. The RBI increased the repo rate by 50 basis points to 5.9 per cent on September 30.

All this makes India's currency, macroeconomic stability, current account deficit and growth rate vulnerable. Finance Minister Nirmala Sitharaman is optimistic that despite the global headwinds, the Indian economy will stay on course. However, India's policymakers cannot remain complacent about the global headwinds, though its economy is not completely coupled with the global economy. In a developing country like India, a modest growth rate of about 5 per cent (as projected by UNCTAD) will push millions into poverty, even if it still makes it the “fastest growing economy”. A depreciating currency and widening "twin deficits" will further fuel an already elevated inflation, which will hit the poorest the hardest.

(The writer is an alumnus of IIM-Ahmedabad and a retired corporate professional)