Even as the market turns volatile due to raging global inflation now exacerbated by the economic sanctions on Russia, and the inevitability of US Fed’s monetary tightening, Viral Acharya, Academic Advisor to the Federal Reserve of New York and Philadelphia sees a real risk of US heading into recession over the next 12-18 months.
“At this level of oil prices and the sudden change in the expectations of six to seven rate hikes of 25 basis points each over the next year, I think one has to seriously take into account the risk of a recession in the United States over the next 12 to 18 months,” Acharya said in an exclusive interview with Moneycontrol.
More significantly, he said, after the Russian crisis started, there are early signs of financial market fragility, but these are not of the magnitude seen during the global financial crisis in 2008 yet. “Headwinds for global growth are coming together into what one might call as a perfect storm. Lots of uncertainty is building up. Lots of risk are on the horizon,” he warned.
“This is not the time for emerging market policy to swing for the fences on growth. I think this is the time to risk manage.” While the stock markets have built in high expectations on growth for India, galloping crude prices is a huge negative India as it reverses the current account balance from a surplus to a deficit of as much as 3.5% of GDP, some economists predict. With financial markets on shaky ground, the continuous selling by foreign investors creates additions woes for the currency. “Financial stability is a trade-off. I would stress that financial stability does require that sometimes you have to make a growth sacrifice.” Acharya said.
Inflation to persist
Acharya said the gap between five year US treasuries and the treasury inflation protected securities are suggesting that inflation might be higher even at the longer horizons. “I think it is going to be a tough year for inflation expectations. Consumer sentiment is down. It may go down even further.” he said.
Household’s form expectations in an adaptive manner, meaning they do not really think about how much of the inflation is led by demand and how much because of supply constraints. Thus, when they see prices of food, fuel, furniture and other goods rise month after month, inflation expectations get anchored at higher levels, Acharya explained. Various surveys in the US show that inflation expectations now are anchored at higher levels. “It's been a really bad series of shocks. But that's the danger, one always has when one leaves reining in inflation to towards the end rather than dealing with the beast once it's beginning to show rear up its ugly head,” Acharya said.
Acharya, like several other economists, feels there is no option on the table for the Fed anymore but to rein in inflation through tightening. “Maybe the asset price corrections, the war, and the sanctions and its after-effects on prices may bring about a consumption contraction faster than what they might be expecting. That may mean they don't have to engage in as much tightening as they would otherwise,” Acharya said. “Some (Fed) governors have hinted at 50 basis points rate hikes in a go, sort of double hikes. That's perhaps more communication rather than what the first hike might turn out to be.”
India risks
As for India, Acharya said, India has to focus on a more even recovery. Although recovery seems to be strong in India too, growth rates had slowed down even before the pandemic and still private consumption and capex are lagging behind. Consumption growth too has been lopsided. “We have to seriously consider the risk that the consumption of the lower income brackets in India is getting eroded. Wealthy can't keep consuming at higher rates to keep taking India's growth to higher levels. Ultimately, the consumption boost has to be across board,” Acharya said.
Notwithstanding the consumption lag, India has been skirting with inflation around 6% for two to three years. The latest CPI for the month of February came in at 6.07%, while WPI was significantly higher at 13.11%.
“We have to recognize that perhaps the slowdown in growth is structural, rather than cyclical. Because if the structure of the economy requires fundamental changes for growth creation, be it disinvestments, reduction of tariffs, ease of doing business, more FDI into some other sectors, creation of service jobs, whatever, this requires work by the government. It's not something monetary policy can keep throwing liquidity and interest rate cuts at,” Acharya said. “Monetary policy should to recognize its limits now and do the job it is required to do which is to anchor inflation at 4% CPI.”
Acharya acknowledged that globally markets are on uncharted territory. “We have not seen what happens when monetary stimulus of this scale is withdrawn. We have not seen inflation of this levels in the United States since seventies.” The war has only complicated the economic situation further, with greater risk of inflation persisting and other potential financial market dislocations.
Policy-makers in India have to be ready to face all kinds of risk – fiscal, external, or any other. “You have to try and structure the economy to be right on all fronts. For that, you have to stress test the economy for various scenarios.” Acharya said.
His biggest worry about India’s economic growth is, however, the lack of jobs growth. “We are not lining up very well with the creation of jobs, and the quality of the jobs we are creating, and their adequacy relative to the needs of our demographic. That worries me the most,” Acharya said.
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