Millennium Post

A challenging course awaits

The new year augurs well for the world economy, judging from a slew of global assessments, and induces hope for a better growth outcome in 2014 for the developing world, notably India though risks abound with all its macro-imbalances and political uncertainties in an election year.

In the latest of these outlook reports, the World Bank has projected growth in India to pick up to 6.2 per cent in fiscal year 2014-2015 from 4.8 per cent in current year, and move on to 6.6 and 7.1 per cent in fiscal 16 and 17 respectively. The bank’s premise in revising up growth rates for the world economy is mainly linked to the emerging bounce in high-income economies, mainly USA and to some extent the eurozone.

The latter is set to leave recession behind, turning growth positive in 2014 but the zone has still risks to solid recovery, given its high unemployment and weak banking sector. Global growth is projected to rise from 2.4 in 2013 to 3.2 per cent in 2014 (at market-based exchange rates) and slightly higher in the next two years to 3.5 per cent. USA, where recovery is stronger relatively, will grow from 1.8 per cent in 2013 to 2,8 in 2014 and edge toward three per cent by 2016. The bank expects stronger growth in India, led by recovery in global demand (in high-income countries) and an increase in domestic investment, to result in gradual closing of a large negative output gap. The main domestic risks, according to the Bank’s Global Economic Prospects 2014, concern the ability of South Asian countries to keep current and planned reforms from going off-track and to maintain fiscal discipline.

A stalling or reversal of policy reforms in India could see significantly lower investment and growth than that projected in the Bank’s baseline. Fiscal and current account deficits remain major negative
factors at present, though the c a deficit has narrowed recently, according to government.

Taking note of of the high rise in India’s fiscal deficit till November, the bank says an inability to maintain fiscal discipline and to reduce subsidies could adversely affect sovereign creditworthiness. Also, political uncertainties related to national elections in Bangladesh and in India in mid-2014 could hamper a sustained revival of business confidence and investment.

The bank notes a strengthening of the world economy (with growth picking up in developing countries and high-income economies) marks a turning point, five years after the global financial crisis. The firming of growth in developing countries is being bolstered by an acceleration in high-income countries and continued strong growth in China at an estimated 7.7 per cent this year and in 2014 and 7.5 per cent over the subsequent two years. Growth prospects in developing and emerging eonomies, however, remain vulnerable to headwinds from a rise in global interest rates and potential volatility in capital flows, as the United States Federal Reserve begins withdrawing its massive monetary stimulus.  While initial implementation of the taper has been very smooth, this gradual process is assumed to continue, resulting in a modest reduction in capital flows to developing countries from 4.6 per cent of their GDP in 2013 to around 4.1 per cent in 2016.

Whatever drag this implies for developing country growth is more than offset by the additional export demand due to stronger high-income country growth, the bank says. At the same time, the bank cautions that if  there is a much more abrupt rise in long-term interest rates,likely,  capital flows to developing countries could decline temporarily by 50 per cent or more for a period of several months – potentially pushing one or more countries into crisis.

Evidence suggests that countries with large current account deficits or those that have had a rapid accumulation of credit in recent years could be most vulnerable to a precipitous tightening of international financial conditions, according to Kaushik Basu, Chief Economist of the World Bank. The bulk of adjustment to the normalisation of monetary policy in high income economies lies ahead and risks would be most pronounced among developing economies with a large share of short-term or foreign debt as a proportion of overall debt, the bank report noted. Policy-makers in these economies should be taking steps now to restructure debt holdings toward longer-term issues and requiring banks to stress-test their loan books and begin provisioning loans at risk. The bank also notes that after the sharp slowdown in the first half, growth in India has rebounded in the third quarter. India’s investment growth slowed sharply in FY2012–2013, but has improved in the first half of the current fiscal year. But growth in South Asia is estimated to have been a very weak 4.6 per cent in 2013, mainly reflecting weakness in India following several years of rising inflation and current account deficits, and high government deficits.

For some countries, the effects of a rapid adjustment in global interest rates and a pullback in capital flows could trigger a balance of payments or domestic financial crisis. Developing countries would be more vulnerable to a deterioration in external financing conditions. Financial sector risks have increased across developing countries and are most pronounced in East Asia. Nevertheless, net private capital flows to South Asia were an estimated $85 billion in 2013 from $92 billion in 2012.

In India, currency and equity pressures only began to subside on indications of an improving trade balance in August and a strengthening of its central bank’s inflation credibility and regulatory changes to encourage the repatriation of capital. Capital flows are stabilising but conditions remain sensitive to developments in high income country developments. There are indications that bond market access for high-risk corporate borrowers has become more constrained in recent months.

With developing countries entering a ‘potentially disruptive period of global financial tightening’, maintaining a business-as-usual policy stance is no longer an option. Policy complacency risks a further accumulation of domestic vulnerabilities.

The daunting political challenge to take measures to boost macroeconomic stability during the transition to higher global interest rates may be made even more difficult given upcoming elections in countries including South Africa, Indonesia, Brazil and India.

Rising productivity and innovation within manufacturing and services will increasingly have to drive growth.


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