About Impending slowdown

Context:

The World Bank and the Asian Development Bank (ADB) recently came up with new growth estimates.

Relevance:

GS Paper 3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Dimensions of the Article:

1. Key points
2. Impact of a possible global slowdown
3. What is economic cycle and its stages?
4. What is Fiscal Policy?
5. Cyclicality of the fiscal policy
6. Basics of Reforms for Countering Economic Slowdown
7. Way Forward

Key points:

• The World Bank and the Asian Development Bank (ADB) projected that global uncertainty will affect economic growth.
• The new growth estimates underline that the Indian economy will slow in 2023-24.
• India’s growth projections:
  • According to the World Bank’s projections, India will grow at 6.3 per cent in 2022-23.
  • The ADB expects growth at 6.4 per cent.
  • The projections are close to what the Economic Survey had forecast in January.
    • It had projected a baseline growth rate of 6.5 per cent with a range of 6-6.8 per cent.
  • These growth estimates are within the given range.
  • These projections could come under pressure and growth could be close to the lower end of the range provided by the Economic Survey, if not below.
  • The estimate of World Bank of 6.9 per cent is close to India’s official estimate of 7 per cent.  
• Global economy growth projections:
  • The global economy, according to the World Bank, is expected to grow 1.8 per cent in 2023 compared to 2.8 per cent in 2022.

Impact of a possible global slowdown:

• It would thus be difficult for the Indian economy to reverse the loss of momentum witnessed in the second half of last fiscal year at a time when the global economy is slowing.
• Banking-sector stress: A possible slowdown of the global economy impact the banking sector can increase uncertainty in financial markets.
• Impact Capital flows:
  • Monetary policy will need to be tightened further to contain Inflation.
  • As a result of this, more banks and financial institutions could come under pressure, which would affect capital flows.
  • Although the current-account deficit has moderated, large outflows can increase volatility in financial markets with implications for growth.
• Decrease in crude oil production:
  • The decision by large crude oil producers to cut production suggests that importers like India cannot perhaps expect relief on this front.
• Geopolitical tensions:
  • Potential escalation in geopolitical tensions could also affect economic outcomes in more ways than one.

What is economic cycle and its stages?

• The economic cycle is the fluctuating state of an economy from periods of economic expansion and contraction. It is usually measured with the Gross Domestic Product (GDP) of a country or region. Other economic factors, such as employment rates, consumer spending, and interest rates, can also be used to determine the stage of the economic cycle.
• The economic cycle is also known as the business cycle, and it is the fluctuating state of a market-based economy. An economy is a term that describes a set of production and consumption activities that determine how resources ought to be allocated. Supply and demand pressures influence the economy through different variables, such as global economic conditions, trade balances, productivity, inflation rates, interest rates, and exchange rates. The variables, in aggregate, shape the economy and the state of the economic cycle.

Stages of Economic cycle

1. Expansion: During the expansion phase, an economy will experience strong growth, and interest rates will generally be lower but will begin to increase as the expansion matures. The overall production level increases, and inflation rates begin to rise as the expansion matures.
2. The Peak: The peak is reached when the growth of an economy reaches a plateau or maximum rate. It is usually characterized by higher inflation that needs to be corrected.
3. Recession: According to National Bureau of Economic Research (NBER) in the United States “During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year”.
4. The Trough: The trough is characterized as a low point in the economy from which it can re-enter an expansionary phase.

What is Fiscal Policy?

• Fiscal policy deals with the government policy concerning changes in the taxation and expenditure overheads and components, while Monetary policy, deals with the changes in the factors and instruments that affect the supply of money in the economy and the rate of interest.
• Fiscal policy is result of several component policies or mix of policy instruments. These include, policy on taxation, subsidy, welfare expenditure, etc; investment or disinvestment strategies; and debt or surplus management.
• Fiscal policy is an important constituent of the overall economic framework of a country and is therefore intimately linked with its general economic policy strategy.’

Cyclicality of the fiscal policy

• Cyclicality of the fiscal policy simply refers to a change in direction of government expenditure and taxes based on economic conditions. These pertain to decisions by policymakers based on the fluctuations in economic growth.
• There are two types of cyclical fiscal policies – counter-cyclical and pro-cyclical.

Basics of Reforms for Countering Economic Slowdown

• Since 1991, the term ‘reforms’ has been used to mean both policy changes that remove restrictions on private sector activity in certain areas and those that increase profits in existing lines of production.
• Thus, to counter the economic slowdown, we need two-pronged strategy
  • Increase the Private sector Investment
  • Adoption of Counter cyclical fiscal policy by the Government.

Way Forward:

• In the given global economic backdrop, it is heartening that the Indian banking system is in relatively good shape.
  • Both corporate and bank balance sheets have improved over the last few years.
• Adopting measures like monetary-policy tightening, growth uncertainty, and lower spending by the government would constrain demand.
• Increase in policy rate:
  • The Reserve Bank of India (RBI) has raised the policy interest rate by 250 basis points in the current cycle so far and is expected to deliver another rate increase soon.
  • Since the inflation rate is above the RBI’s tolerance band, it is likely that the policy interest rate will remain elevated for some time, which would affect demand.
• Fiscal consolidation:
  • On the fiscal front, the government has to move forward on the consolidation path and will not be in a position to support growth in the medium term without slippage risks.
• Therefore a well calculated monetary and fiscal policy measures can strengthen macroeconomic stability