Tuesday, June 18, 2024

How will the global banking crisis affect India’s economy?

There have been fresh concerns about the state of the global economy following the closure of Silicon Valley Bank and the spread of liquidity troubles to smaller US banks and Credit Suisse. Will the global banking crisis hurt India’s economy, and if so, in what way?

The global economy isn’t in great shape. On Monday, the World Bank cautioned that it is at risk of suffering a ‘lost decade’ in terms of growth. This isn’t inevitable, the bank said, but added that preventing it would take “a Herculean collective policy effort”.

The World Bank, thus, joins the group of analysts that believe the global economy is unlikely to escape lasting damage caused by the Covid-19 pandemic and Russia’s invasion of Ukraine, and may tip into recession. It’s especially concerned about the setback in the fight against poverty and climate change and worries that these shocks have slowed the global economy’s potential growth to its weakest in 30 years.

If the current instability in financial markets does end up triggering a global recession, the decadal slowdown could be even more severe, the bank warned (though another set of analysts still says just as emphatically that this is unlikely). The World Bank’s latest projections suggest that the global economy can sustain a growth rate of only 2.2% a year for the rest of this decade, down from 2.6% between 2011 and 2021 and 3.5% in the first decade of this century.

Indermit Gill, its chief economist, explained that sustainable growth will suffer as there will be “less work, less investment and less trade” compared to the 1990s and 2000s, when the world saw rapid growth and development.

To understand the implications of the banking crisis and bleak global economic outlook for India, let’s first separate out the myriad forces at work.

First, the stability of global financial markets is being tested. While most analysts expect the US banking sector to hold up, and are most likely right to feel confident in its ability to avert a replay of the 2008 global financial crisis, one complication still remains – that the Fed is now balancing financial stability against inflation. Already, there are signs that it may end up going slower on monetary tightening than previously believed, in spite of the US economy remaining strong and inflation remaining a threat.

Second, it is likely that the impact of synchronised policy tightening by advanced economy central banks over the past year may now begin to show.

Third, reduced and more tightly regulated lending in the US will also have an impact.

How these factors will interact is difficult to predict at this point. All that can be said with certainty is that uncertainty has increased. Two things can change unpredictably and will be closely watched: One, how the financial markets situation evolves, and two, what economic policymakers do.

In this situation, even without further monetary policy tightening, the global cost of capital can only rise. Increased uncertainty all over again will also hamper investment plans.

The implications are already showing up in high-profile announcements regarding layoffs and global hiring decisions. All of these will result in increased precautionary savings and reduced consumer spending, which does not augur well for India’s export sector – although it could also mean lower inflation, which will help India in no small measure.

India won’t have to worry about financial stability as its banking sector is closed. Accelerated capital outflows in case of reduced risk appetites won’t pose much of a challenge either, given India’s huge foreign exchange reserves.

But the country will still have to cope with rising uncertainty. Investors will remain wary and consumers’ discretionary demand will not rebound in a hurry. A full-fledged reversal of the decade-long private investments slowdown will take even longer.

Monday’s World Bank report said, “The steepest slowdown in investment growth over two decades to 2021 occurred in India… Investment growth in India slowed from an annual average of 10.5% in 2000-10 to 5.7% in 2011-21.”

India, therefore, will be affected through the following channels: the general dip in business and consumer confidence amid the rising risk of a lost decade for the global economy, and higher uncertainty levels, which will result in lower demand for exports, higher cost of capital, and further delays in the revival of private investments.

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