IMF's Gita Gopinath On Growth, Inflation And The Risk From Fed Tightening
Inflation levels are expected to ease in the second half of the year, and this year will mark an exit from extraordinary policy measures that were in place through the pandemic, according to IMF's Gita Gopinath.
A host of standard and non-standard economic factors are coming together to push up levels of inflation globally, particularly in developed markets like the U.S.
While the International Monetary Fund expects inflation levels to ease in the latter half of this year, it would remain elevated and prompt an exit from extraordinary policies used to support the economy through the pandemic, said Gita Gopinath, first managing director at the fund in an interview with BloombergQuint.
This is the year of the exit from extraordinary policy measures in pretty much all major economies, Gopinath said. "The Fed is certainly going to be raising interest rates multiple times this year. So, exiting the extraordinary policy support provided is on the cards."
A withdrawal of monetary policy accommodation in large economies like the U.S. could lead to market turbulence and tighter financial market conditions. The IMF and Gopinath see this as a risk to the outlook for emerging markets this year. But it won't be a 'one-size-fits-all' story and economies with lower reliance on global capital could be less vulnerable, Gopinath said.
Edited excerpts from the interview:
The IMF has cut growth projections for 2022, led by downgrades for the U.S. and China. For China, the real estate sector is impacting the outlook, while in the U.S., it is lower fiscal support and a turn in monetary policy?
There are very different factors behind the downgrades for the U.S. and China. For the U.S., in addition to what you mentioned, it is also that supply disruptions have lasted longer than expected.
In the case of China, what we are seeing is even greater weakness in the real estate sector than we anticipated. In addition, there are more lockdowns and targeted localised lockdowns in China because of Omicron and the zero-Covid strategy that they have. That has been impacting private consumption in China.
For the rest of the world, will 2022 be the year when you get a clearer sense of the underlying growth momentum?
This is certainly a year when we are hoping to get closer to normal in an economic sense. We hope that, over time, there will be a rotation of demand back from goods demand towards services demand. And that will have implications for inflation too.
This is also the year of the exit from extraordinary policy measures in pretty much all major economies. The Fed is certainly going to be raising interest rates multiple times this year. So, exiting the extraordinary policy support provided is on the cards.
The hope also is that we get used to dealing with newer variants and we go back more to normalcy, spending patterns return more to normalcy. But again, I think what is absolutely true about this year, just like previous years, is a very high level of uncertainty around the outlook.
On inflation, is it your assessment that it is still driven by supply-side factors and energy prices? What are the risks here?
Our prognosis is not that it is entirely supply-driven. There has been a strong rebound in demand, which has also fed into commodity prices. So for commodity prices, it is not just a supply story but also a big recovery in demand that we have seen.
There are the standard factors that have an impact on inflation, which is the amount of fiscal stimulus provided, the monetary policy stance, the behavioural aspects; for instance, how quickly people come back to spending. You combine those standard factors with a whole bunch of non-standard features; for instance, people spending more on goods rather than going to restaurants, or workers falling sick and being held back from returning to work, and some picking early retirement, and the global supply chain breakdowns.
So, it is a complicated process to forecast the path of inflation. Our expectation is that from the second half of the year, we would see inflation coming down pretty much in all countries. But for some countries, like the U.S., even though it comes down, it still ends the year elevated and above the 2% target for the Fed.
Are you seeing current inflation trends start to feed into inflation expectations and the second round effects that follow, at least in the U.S.?
In the U.S., if you look at medium-term inflation expectations, they look well-behaved and anchored. The very near-term inflation expectations have gone up consistent with what we are seeing in terms of the recent inflation data.
But if you see the labour markets, they are quite tight. We are seeing nominal wages go up at a rate faster than pre-Covid. But again, while there has been an increase, we are certainly not seeing a wage price spiral. We are seeing wages going up for some workers, such as those that work in leisure and hospitality, less so for other sectors.
So, while overall wage inflation has picked up and that's one of the reasons why you have more broad-based price inflation and the U.S. Fed will be raising interest rates, but we are not in a wage price spiral or in a place where we have de-anchored inflation expectation.
What are the implications of Fed tightening for global markets and emerging economies?
That is one of the risks that we flag. If it so happens that interest rates start rising even faster than we expect, given the U.S. interest rate increases or if there is excessive turbulence and costs shoot up all around the world, then that certainly will have an impact on many emerging and developing economies. But again, it is not a one-story-fits-all (approach).
Compared to 2013-14, there are several countries which have more foreign exchange reserves. Several countries have not received large inflows and they do not rely heavily on foreign currency borrowings. On the other hand, there are countries that have large external financing needs, that are borrowing in dollars, and they are particularly susceptible.
The IMF has cut India's growth projection for this year but raised it for next year to 9%. What are the factors driving the change in outlook?
India has been recovering but there is still quite a bit of gap between where it is right now and its potential in terms of the level of output it could have. And so, there is underlying momentum where we should continue to see a recovery in consumption and investment. It is a gradual recovery compared to the pre-pandemic trend.
We have a small downgrade to growth this year because of Omicron and its concentration in the first quarter of this calendar year. That postpones the recovery a bit which is why the number for next fiscal goes up. Again, there is a lot of uncertainty.
On the plus side, the stress we were seeing in the financial sector is somewhat less than last year and that can be a positive in terms of the recovery. But it is a pretty challenging environment within India and globally, given monetary policy tightening in the U.S. and its implications for interest rates, alongside energy prices which could shoot up some more. All of these could be challenges for India.
India's monetary policy authorities have remained accommodative because they see the growth as fragile. Is it time for them to shift their focus back to inflation while allowing fiscal policy to address growth concerns?
Inflation has been close to the upper band; core inflation has been pretty sticky close to the upper end of the RBI's tolerance band. While it is not substantially above that, this is something to keep an eye on.
There is slack in the economy; that gives you pause to say they are still waiting for a recovery. At the same time, these things can change pretty quickly. A long period of inflation stuck at a particular number can shift expectations up. So, it is something to pay attention to.
The RBI has been communicating strongly, but it would be helpful to communicate some more on the interest rate path, specially in this global environment when the U.S. Fed is going to start tightening.
On the fiscal side, what do you see as priorities for India?
Our view is that India's fiscal policy can stay accommodative for some more time. If you look at the cyclically adjusted fiscal deficit, it should have a neutral stance which means the overall deficit would look somewhat accommodative.
In terms of where the budget should go, there is certainly one piece that should address the very unequal recovery within the economy. One dimension is making sure the rural employment guarantee scheme remains well-funded. One could consider providing free food staples for somewhat longer rather than letting it expire in March.
The other big area where attention is required is spending on health, on education because schools have been shut for a long time and there is a big impact there.
The government has been spending on public infrastructure investment. That should continue, alongside the asset monetisation programme. All of this should be done while communicating a credible medium-term fiscal framework on how deficits would be brought down. That would be required to ensure that financing costs for India remain well behaved in this environment where we are moving towards interest rates going up in major economies.