The Recession Prophecy: India’s Bottom Line

In the long run, we are all dead.

– John Maynard Keynes

When we start to analyse a topic as broad as recession and global macroeconomics, it’s important to cover a lot of ground. There are numerous factors involved in its research and various schools of thought that come up with widely different results. 

India is an emerging economy and the case with many emerging economies is that its performance is largely dependent on the global scenario, especially the macroeconomic realities of the US.

 

With that in mind, let’s look at how the World and Indian economy functioned in the recent past:

During the pandemic, all major economies went into lockdown and that shattered the global economy. To stave off an even worse situation, the US started to provide trillions as stimulus checks to boost the economy while keeping the interest rate as low as possible. The global demand for crude oil went to an all time low because lockdowns largely reduced the demand.

Keep in mind that when the US Recession ends, India always benefits from the US post recession scenario. As the US reduces interest rates to tackle recession, money flows into our nation in the form of FPI, FDI and FIIs. Furthermore, India’s biggest import is crude oil. So, when the biggest consumer of Crude Oil (USA) goes into a recession, Crude Oil becomes a lot cheaper and we greatly benefit from that. 

We saw this come into fruition in 2021, when India saw a great boost to its economy and the equity markets on the back of the post US recession effects and the pent up demand seen in the post lockdown era.

Fast forward to 2022, The Present

The US had managed to avoid a bigger fallout in the pandemic due to the significant amount of monetary stimulus. However, the stimulus has resulted in significant inflation in the US. The US targeted ideal inflation rate would be 2% but the US inflation rate was 8.6% in May, 2022. Inflation tarnishes the purchasing power of the consumer and if left unchecked can wreak havoc in the economy like it did in Venezuela, Germany and Zimbabwe in the past. To tame inflation, the US Federal Reserve has decided to raise interest rates. Raising interest rates leads to bringing inflation down but the contractionary policy comes with a risk of putting the economy back into a recession.

The current situation is reminiscent of the US back in the 1970s when inflation had peaked at  around 14%. To tackle this situation the then Fed Chairman Paul Volcker had to raise interest rates to about 20% to tame the roaring inflation. However, the interest rate hike came at the cost of back to back recessions. 

Right now, we are still in the early phases of the curve where inflation is 8.6% and the Fed has announced subsequent rate hikes but none as dramatic as Volcker’s.

India’s current situation has been largely affected by these factors and more. The Fed Interest Rate hikes have resulted in a big selloff in Indian markets with foreign funds being pulled out of the Indian markets which led to the weakening of the Indian currency. On top of that, the price of Crude Oil has drastically gone up to around $100 a barrel since the pandemic low which has caused the current account deficit of India to increase. Along with that, the Ukraine – Russia conflict led to a rise in food inflations and Chinese COVID lockdowns have brought about global supply chain issues. All these factors combined sure paints a grim picture of India’s economy in today’s time.

What does the future hold?

This is where things get tricky. Accounting for the past and the present is straightforward but estimating what the future holds is complicated. Different schools of thoughts arise and perspective becomes more than just a noun. 

In the U.S, the Fed and several notable economists seem to think that the systematic transitory interest rate hikes will get inflation in check and the most realistic situation is an oncoming ‘mild recession’.

On the other hand, few are of the belief that the U.S have a severe recession in their future. To delve in deeper as to how, this may be the case. We need to understand that the economy is majorly driven by personal consumption expenditure. High inflation has led to the belief that consumer’s purchasing power has greatly decreased. Necessities like food and gasoline prices have shot up due to inflation. The stimulus checks helped the consumers during the pandemic crisis but the household savings rate in the US has fallen deeply as depicted by the figure below:

The consumer sentiment index by the University of Michigan which tracks the US’s consumer sentiment has reached an all time low. So, a consumer recession is a great possibility. Additionally, as consumers spend less, companies’ sales decline. As seen by the decline in Amazon’s growth even when it is leading the marketplace by every measure. Since wages are sticky, the profit margins of companies will decline as sales will fall more quicky than wages which can lead to an earnings recession as well.

This fall in consumer demand was not predicted properly by firms which have overstocked and have mammoth sized inventories. This is a classic case of the ‘Bullwhip effect’. The oversupply will force firms to cut their prices, which might lead to momentary disinflation pulse in CPI which the Fed will use to again start pursuing quantitative easing. However, since the longer term inflationary pressures are still present which are bound to overweigh the temporary disinflationary pulse, roaring inflation can very well make a comeback. 

Some thinkers have gone even further to doubt the effectiveness and as well as the incentives of the Federal Reserve. Believing that, the Fed does not have the decisive convictions to actually strangle inflation.

What does the future for India look like?

India will possibly go through a period of slowdown in its economy. Foreign funds will avoid the Emerging Markets. Crude Oil will be affected by wars and sanctions. However, the longer term future is pro – India. As explained earlier, India greatly benefits from a post US recession scenario. Along with that, as geopolitical upheavals cool down, crude oil prices will decrease. India’s service based future economy has a bright future ahead of itself. India’s growth story might even possess a resemblance to the 1970s Japan story or the 1908s USA that saw its economy progress on the backs of technological innovations along with huge structural reforms. Also, unlike China’s manufacturing led growth that we see now, which has resulted in a backlash from developed economies, a service led growth might not be a victim of that.

Crude Oil prices rise and Food Inflations are momentary shocks to the Indian growth wheel but the longer term progress of India seems to be largely optimistic.