MC Explains | The polycrisis and why we need to worry about it

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May you live in interesting times. This ancient Chinese curse is an apt one for the world we live in today, what with the pandemic, the resurgence of geopolitical conflicts, financial and economic turmoil, and heightening anxieties over climate change.

On the economic front, the world has been facing a so-called polycrisis over the past couple of years, with accelerating inflation leading to sharp monetary tightening globally and the energy crisis fallout of the war in Europe.

The ambit of the polycrisis is now widening – there is a US variant in the making with no signs of its banking crisis ebbing as well as continued political brinkmanship over the US debt ceiling.

As recently as last week, finance leaders of the richest countries at the G7 grouping warned of heightening global economic uncertainty going ahead.

So what’s a polycrisis?

A polycrisis can be defined as the simultaneous occurrence of several catastrophic events that are often entangled. Think the war in Ukraine, the jump in inflation, the pandemic, the geopolitical shifts, and deglobalisation.

Still, until last year, a large part of the crisis was concentrated in Europe. That’s not the case anymore.

What’s happening in the US?

The world’s largest economy is headed for a recession as the impact of sharp monetary policy tightening takes effect and as the banking crisis leads to tighter financial conditions. On top of that, legislators are in a tussle yet again over whether the US government statutory debt ceiling should be raised.

Nomura predicts that a recession is likely to start in the US in the third quarter of 2023. Meanwhile, the Federal Reserve may finally halt its interest rate increases and cuts could be on the anvil early next year.

Unfortunately, despite the looming recession, high inflation, a divided government and the debt ceiling impasse will likely prevent policy support from fiscal authorities, according to Nomura. Both the US and Europe are eying regulatory tightening to better protect depositors after the recent failure of regional banks in the US.

“There appears to be no respite from seemingly never-ending economic crises and concern,” Carsten Brzeski, the global head of macro for ING Research, said in a note last week. “The banking crisis in the US is far from over, and even if regulators have been very efficient in ring-fencing failing institutions up to now, we all know the adage that ‘past performance is no guarantee of future success,’ and it's rarely been so true for financial markets right now.”

The debt ceiling looms.

A US Council of Economic Advisors study shows that a short default on US treasuries would cost 0.6 percentage points of GDP growth, while a protracted period would cost more than 6 percentage points. Even if there is a last-minute compromise on the debt limit, the uncertainty and expenditure cuts will weigh on growth, worsening the US polycrisis.

All is not lost.

The banking sector turmoil in the US is more idiosyncratic than systemic, and amid an expected slowdown, its net effect would be negative, but not extreme, according to Seth B Carpenter, chief global economist at Morgan Stanley & Co.

Also read: More financial institutions may fail globally, but no direct impact on India likely: PM’s advisory council member

How India has managed

Policymakers in New Delhi and Mint Street have been watching the global polycrisis unfold over the past few years, moving policy levers as appropriate.

There was a lot of consternation on the global stage when India did not stand with the West in condemning Russia outright after the war began and instead boosted its crude oil purchases from the country. For now, it seems India has managed to benefit from its stance and has diversified its oil source bucket.

The Reserve Bank of India has also taken steps towards the internationalisation of the rupee, a process that will unfold over the long term.

The finance ministry and the RBI worked in tandem last year when inflation spiked, as it did in the rest of the world. While supply-side measures and tax tweaks have helped cool price spikes, the lagged impact of monetary tightening is also likely taking effect.

Also read: Stable banking system, RBI regulations help avert SVB-like crisis in India: Finmin

The government has aimed for another capex-heavy budget this year, even while trimming the fiscal deficit in line with its fiscal consolidation path. Still, adverse weather shocks and weaker global growth threaten economic expansion.

The strategy is likely to focus more on internal drivers of demand, as suggested by the finance ministry’s chief economic adviser last year.

For now, the Indian financial sector is well-protected from the daunting global financial situation due to well-regulated systems, economic affairs secretary Ajay Seth said earlier this month after a meeting of India’s Financial Stability and Development Council.