Flying through headwinds
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Rising inflation affects everyone including this worker in Pettah.
When the late Prime Minister of Japan, Shinzo Abe was elected to office in 2012, he had to deal with Japan’s unusual macroeconomic problem – deflation. Japan was a country that had been caught up in a “deflationary” problem since the 1990s. Deflation is the term for decline in average prices.
Although consumers are cheerful about living in a situation with “deflation”, it is as bad as inflation, if not worse than inflation. In a deflationary situation, consumers anticipate “lower prices in the future” so, they keep postponing their spending. As a result aggregate demand falls, causing slower or negative growth of the economy. Public debt accumulates and interest rates fall.
Throughout his term in office, Mr. Abe tried achieving just 2 per cent annual inflation with ultra-loose monetary policies, aggressive fiscal spending and structural reforms, but failed. And he stepped down from office in September 2020. By that time, the entire world economy had been caught up by the COVID-19 pandemic. The deflationary pressure was seen sweeping across advanced countries – US, Europe and UK, while developing countries too experienced sharp decline in inflation.
Now the world’s deflationary problem is upside-down! It blows across the world like a headwind through which the recovery phase of the world economy is not easy. In fact, Japan is not an exception anymore; what it failed to achieve throughout three decades was doubled the target of Mr. Abe reaching 4 per cent last December.
Inflationary pressure
The world economy has been reporting historically unusual inflationary risks since the end of 2021. The US reported its highest rate of inflation reaching over 8 per cent, the Euro area and the UK over 10 per cent in October last year.
Along with increased inflationary pressure, the next thing that we must expect is the monetary policy tightening. The US Federal Reserve Bank started increasing its policy rates – the so-called Fed Fund Rates – from 0.25 in the early 2022 to 4.75 in early 2023. The European Central Bank too raised its policy rates from zero in the early part of 2022 to 3 per cent in early 2023. The Bank of England too raised its policy rates from just above zero a year ago to 4 per cent in early 2023.
Most of the analyses have attributed the world inflationary pressure to the sudden influx of consumer demand after easing the lockdown in the world economic affairs. It was also contributed by the increased world energy and food prices at the time causing their multiple repercussions over the average price increase. A man-made contributory factor of inflation is the Russia – Ukraine war which has pushed up both energy and food prices directly and, caused disruptions to smooth functioning of the international economic affairs.
Global inflationary pressure is expected to fall this year, while it has already begun in the US, UK and Europe. The interest rate hikes have eased inflationary pressure through the reduction in aggregate demand. Nevertheless, the next thing that we must anticipate is that it would lead to slower growth. Therefore, it has been through these tight monetary policies that the recovery of the world economy must go through a hard time.
Retarded recovery
It was on September 12, 2021, that I wrote a column under the title “Bitter policy dose after vaccines”. The commentary analysed that, as the global vaccination programme was advancing all around the world, it should be followed by monetary tightening in order to tame rising inflationary pressure. We have already seen the global inflationary pressure in its full swing as well as the bitter policy response since the second quarter of 2022.
The world economy that reflected a strong growth recovery in 2021 is estimated to slow down last year (2022) as well as this year 2023. As the COVID-19 fear and its negative impact on the world economy disappeared in 2021, the world economy is reported to have grown by 6.2 per cent. It was contributed by strong economic growth in both advanced and developing countries alike.
Unfortunately, it was not sustained in the subsequent two years, not even in the developing countries. While the Central Bank fight against inflation across the world has pulled back the growth impetus, the tight borrowing costs due to higher interest rates held back the anticipated economic recovery. The slowdown in growth rates in the advanced region in the world is a massive blow to the world economy. The world’s advanced regions comprising the US, UK, Euro area and Japan which constitute nearly half of the world GDP play a critical role in global aggregate demand and in international trade.
Growth in large economies
The two fastest growing large economies in Asia – China and India – are also due to experience slower growth. Economic growth of China as the world’s second largest economy, and of India as the world’s fifth largest economy, is influencing the economic expansion in emerging and developing regions. Chinese growth slowed down significantly due to a renewed health crisis in 2022 and related economic repercussions, and thus India continued to remain the highest growth centre in Asia.
India also made a historic turning point this year in becoming the world’s most populous country surpassing China. In order to place India’s population growth in a perspective, those days we used to say that “every year one Sri Lanka (population-wise) is born in India”. While the country has awakened to grow faster, it has also become attractive to foreign investment, including investment from global smartphone giants, Samsung and Apple.
In her opening remarks of the Budget Speech 2023-2024 a few weeks ago, India’s Minister of Finance, Nirmala Sitharaman stated that: “In the 75th year of our Independence [2022], the world has recognised the Indian economy as a ‘bright star’. Our current year’s economic growth is estimated to be at 7 per cent. It is notable that this is the highest among all the major economies. This is in spite of the massive slowdown globally caused by COVID-19 and a war. The Indian economy is therefore on the right track, and despite a time of challenges, heading towards a bright future.”
Asian economic growth, led by both China and India is therefore set to record a significant leap forward, in spite of recurring global issues. The growth of these two large economies is important for sustaining growth in other Asian countries as well.
Crash-landing
Well, in the midst of global turbulent times, there are countries which have been caught up in the debt crises, while in this group Sri Lanka is one among the top crisis-ridden economies in Asia. Even if the world economy is expected to perform better in the coming years, as anticipated, whether Sri Lanka could make use of it for the country’s future growth remains a valid question.
Unless and until Sri Lanka undertakes a purposive bold reform programme in the areas where it made its own contribution to drive the economy towards current crisis, it would be difficult for Sri Lanka to guarantee its recovery and long-term growth. As I conclude this write up today, it seems that we, as a nation, are interested more in politics and political power than in economics and our economic mess!
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).
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