The new forecast of the Organization for Economic Cooperation and Development shows that global growth in the current year will slip to its slowest since the financial crisis, largely because of the ongoing trade war. On Wednesday, the Federal Open Market Committee (FOMC) of the US Federal Reserve reduced policy interest rates by 25 basis points to support the US economy. This was after the European Central Bank pushed interest rate on its deposit facility further into negative territory and announced a plan to restart asset purchase without an end date. However, aside from the decision to reduce policy rates, the other commonality in both the central banks was the division among officials. In a way, this reflects the state of the global economy and difficulties in policymaking.
For instance, the Fed saw three dissent votes in the FOMC meeting. Also, there was a clear spilt among officials in projecting the course of the policy. Similarly, several member countries in the European Union were not in favour of restarting quantitative easing. Asset purchase by the ECB, among other things, could lead to dislocation in financial markets and escalate trade tensions. It will increase the supply of euros in the system and put downward pressure on the exchange rate, which would help exporters in the region. The market condition would encourage global money managers to shift from Europe to other countries, particularly the US, which will strengthen the dollar. US President Donald Trump accused the ECB of manipulating the euro in the past. Clearly, its latest move will not please Mr Trump, who firmly believes that the US is being treated unfairly by its trading partners. Also, this would encourage other countries, both in the developed and emerging markets, to manage their currencies more aggressively, potentially leading to further escalation in trade tensions. The US-China trade war is anyway affecting the global economy significantly. A recent note by the Fed, for instance, showed that trade policy uncertainty in the first half of 2018 accounts for a decline in global gross domestic product by about 0.8 per cent by the first half of the current year.
Trade uncertainty is likely to remain a drag on global growth in the foreseeable future. While the central banks are doing their bit to contain the damage, there are limits to what they can achieve in an unsupportive policy environment. Fed Chairman Jerome Powell
in his remarks at the recent Jackson Hole conference, for example, noted: “…while monetary policy is a powerful tool that works to support consumer spending, business investment, and public confidence, it cannot provide a settled rulebook for international trade.” Besides slower economic growth and trade and currency issues, the global economy also has to deal with higher oil prices and geopolitical tension in West Asia. An escalation would affect the global growth.
The ongoing uncertainty in the global economy will only add to India’s problems and could prolong the slowdown. While emerging market countries like India tend to benefit from monetary accommodation in the advanced economies because of higher capital flows, an increase in risk aversion in the global financial system could reverse flows. In the given global economic situation, policymakers in India should redouble efforts to build investor confidence through reforms that would increase the ease of doing business and by protecting macroeconomic stability.