Sobering outlook

The International Monetary Fund’s sober forecast for global growth in the current year, down to 4.3 per cent from last year’s 5.1 per cent, should not come as a surprise to most as the signs of a slower tempo have been there for some time.

For one, there aren’t too many instances, if any, of world growth averaging over 5 per cent for two years in a row. Second, while it is true that oil prices have retreated each time the spectre of $70-80 per barrel has been raised, since OPEC obliges by pumping out more crude, the fact is that China is barrelling along at 8-9 per cent growth and India at only a slightly more sedate 6-7 per cent.

This can only serve to dramatically increase demand, which has been rising faster than supply. The IMF therefore reckons that higher oil prices could shave off global growth by anywhere between a quarter and a half of a percentage point.

The third set of factors is focused on the US and China. The unstable nature of the US economy has been obvious for several years, with the US administration apparently unmoved by the twin (and still rising) deficits on the fiscal and trade accounts; the resulting speculation on the future of the dollar may have become a tired story but, remarkably, the debate is still on as to whether the dollar will fall or climb.

A significant US interest rate hike is now on the cards, and this too will serve to slow growth. In China, by contrast, the speculation has been on whether its headlong growth will slow down—and what that would mean for commodity prices around the world.

These have retreated from their highs over the past year, but some items still enjoy rising price curves; the smart money today seems to be betting on Chinese demand slackening well before the Beijing Olympics of 2008. That too points to a slowing of the world’s economic tempo.

The question for Indian authorities is what they can and should do. Though export demand is now more important than before for many Indian busnesses, the sources of growth in India are still largely domestic.

In that sense, there is little to be done. Defences against an external shock also exist, in terms of a balanced trade account and large foreign currency reserves. The trick would be to not make the wrong moves if the stock market were to seek a correction, or the rupee take a hit.

There will also be some pressure to raise domestic interest rates in step with the US Fed, but this should be done with moderation since Indian businesses are in the middle of the investment cycle.

The more important objective should be to control the deficit because the government has an ambitious borrowing programme in an environment of rising interest rates, and this could easily feed the deficit through the higher cost of money.