Five questions for 2023

Business Standard, 12 December 2022

Many of us tend to retain our old mental models, and think of India in an autarkic way. Connections into the world are, however, remarkably important for India. As with the pandemic period, developments in the world economy are likely to have an important impact upon the Indian economy. In this article we look at the five big questions which will shape the world economy, and thus impinge upon India, in 2023.

India is more internationalised than we think

There are many impediments to globalisation in India. From 2014-15 to 2021-22, flows on the current account grew by 5.3% per year on average, measured in nominal USD, which is a slow rate. Despite this, the external sector is rather important. First, let's look at the magnitudes. In 2021-22, $0.84 trillion went out and $0.8 trillion came in, on the current account. These are fairly large values.

Second, export growth was important in holding up the economy during the pandemic. Non-oil non-gold exports were at $40 billion a month before the pandemic. They grew well under the influence of macro policy in developed markets, and rose to $55 billion a month by late 2021. This was an important source of strength for the economy at a time of weakness in domestic consumption or investment. The size of this gain (of about $15 billion or about Rs.1.2 lakh crore per month) was material, and emphasises the importance of the external sector in today's India.

And then, in 2022, we got a vivid example of how global events shape Indian exports growth. Two external events happened in February: Russia invaded Ukraine and the US Fed started raising rates. This was also the timepoint where the exports boom ended; non-oil non-gold exports from February to September 2022 has stagnated at about $55 billion a month. This emphasises the links between global events and Indian exports.

The five big questions around the world economy for 2023

Hence, as the end of the year approaches, it's interesting to take stock of the global economic landscape, to identify the five issues which will matter in 2023.

1. Many think that the US Fed tightening is largely completed. Given sustained inflation and economic strength in the US, however, there is a reasonable possibility that these rate hikes will run ending at above the consensus value of 5 per cent. To the extent that this happens, we will see an accentuation of the global financial stress that goes with DM rate hikes, where the required rate of return in emerging markets rises, and the illiquid + risky corners of the world economy experience difficulties. We may get sustained rate hikes in India by RBI as it tries to prevent USD/INR depreciation.

What if the US Fed accepts inflation above 2% and stops hiking? This would create easier financing conditions in India. But it would also be a scenario of inferior medium term US economic performance, which is bad for India.

2. China has been absorbed in the combination of the zero-covid policy and hostilities with most of the world. As China is an important part of the world economy, a resumption of normalcy there will assist the global recovery. But we are looking at the possibility of reduced Covid restrictions while coverage with foreign vaccines is poor. This could become like India's second wave.

3. Many entities worldwide (governments, firms, households) built up a lot of debt during the pandemic. Present interest rates, and the likely scenario of higher interest rates in 2023, will drive many of these into distress. Debt substainability (at all these three levels) reflects a comparison between the nominal GDP growth rate and the interest rate. Many an entity in 2023 will face credit stress in this environment of poor growth and rising interest rates.

4. The war in Ukraine is an important drag upon the European economy. Russia is trying to coerce Europe into reducing support for Ukraine by choking energy supplies, and Europe is reeling under this energy shock. High energy prices in Europe kicked off massive investments for renewables and for energy security. It is likely that conditions in 2023 will be better. Winter temperatures in December '22, January '23 and February '23 are important. There is concern about gas inventory in Europe in late 2023, and this concern will generate sustained European LNG purchases all through 2023.

The sanctions regime is hobbling the Russian economy, which improves the chances of the war ending. But even when the Russian invasion ends, Europe is unlikely to accept energy dependence upon the present Russian regime, so the energy difficulties in Europe are likely to only ease slowly.

5. And then, there are the things that go bump in the night. Faced with these difficulties (US interest rates, Chinese economy, debt sustainability, the war in Ukraine), there is always the possibility of some pockets of the world economy (and India) getting into trouble. Authoritarian regimes are more susceptible to political upheavals, and this political risk is present in places such as China, Russia, Iran, etc.

Finally, there is the problem of model risk. We are not in normal terrain. The traditional numerical values and relationships between economic variables will not play out. The users of these historical relationships will be surprised. This is also a time for inter-disciplinary thinking, to step out of the economics lane, and look at the full range of forces at work and mechanisms of influence that do not respect disciplinary boundaries.

In conclusion

We tend to look at the forecast for 2023, where there is a consensus on a mild global recession. It is more important to look at the uncertainties surrounding the measure of location. These five questions -- US monetary policy, Chinese economic outcomes, coping with high debt, the European path to recovery, and unexpected air pockets -- will shape the world economy in 2023. Strategists in India need to watch them, evolve a view on each of them, think about how alternative scenarios will impact on their objectives, and develop defensive strategies for the variety of adverse scenarios.

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