Opinion As central banks tighten policy to fight inflation, the global economic outlook appears to be worsening

Two years after the global economy went through one of the most severe economic downturns in recent history, the economic outlook is once again clouded. In the July update of its World Economic Outlook, the International Monetary Fund (IMF) has slashed its forecast for global growth this year to 3.2 per cent, down from its earlier expectations of 3.6 per cent. These latest projections imply that world economic growth, after rebounding to 6.1 per cent in 2021, will slow down sharply to 3.2 per cent in 2022. Equally worrying is the even more severe revision in growth expectations for next year —the Fund now expects growth at 2.9 per cent, down 0.7 percentage points from its April forecast.

In large part, the lowering of growth projections is driven by expectations of a sharp slowdown in developed economies, the US in particular, as central banks tighten policy to fight surging inflation. Inflation is a global phenomenon —the Fund has upped its forecasts on the back of higher food and energy prices. It now expects inflation at 6.6 per cent in advanced economies and 9.5 per cent in emerging market and developing economies. The tightening of monetary conditions will impact output. Data released on Thursday showed that the US economy had contracted in the second quarter as spending by business fell, and the pace of consumer expenditure slowed down. A day prior to that, the US Federal Reserve hiked its policy rate by 75 basis points for the second time, raising the rate to 2.25-2.5 per cent, as inflation hit record highs. Following the Fed’s decision, the view that the US central bank will ease the pace of rate hikes is gaining traction. However, with the labour market remaining quite tight, there is considerable uncertainty over how much and how quickly the Fed will tighten further. A recession in the US, differences in the definition notwithstanding, along with a sharp slowdown in China —the Fund has lowered its growth forecast for the country by 1.1 percentage points —will have grave consequences for the world economy.

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For India, the Fund has lowered its expectations from 8.2 per cent to 7.4 per cent. This is in line with the RBI’s forecast which expects growth at 7.2 per cent. However, even by the RBI’s own assessment, growth will average just about 4 per cent in the second half of the year. Considering the current macroeconomic environment of slowing global growth and trade and a tightening of monetary conditions, with domestic drivers of growth subdued, returning to a higher growth trajectory could prove to be difficult.