As central banks wind back the pandemic-era measures which were intended to support growth during an economic downturn, the fears of a prolonged recession have emerged fuelled by a sharp uptick in inflationary pressures and poor demand recovery. Add to this the Covid situation in China and the Russia-Ukraine war, the global economy is in a vexing position.

Generally speaking, India would enter a ‘technical recession’ when it sees two consequent quarters of GDP decline. Cambridge, USA-based National Bureau of Economic Research (NBER) however, defines a recession as a ‘significant decline in economic activity that is spread across the economy and that lasts more than a few months.’

In a conversation with
ET Online, global research firm Nomura’s Sonal Varma, Chief Economist – India and Asia ex-Japan, said that amid the current geopolitical developments and central banks’ policy rollback, India may see an economic slowdown in the medium term.

“There is a risk that if the export cycle globally slows and domestic policy is tightened then over the next 12-18 months we could see a slowdown in India. It is not a recession, but growth slowdown risk is definitely more elevated from the medium-term perspective, i.e, in the next 12-18 months,” Varma said.

In recent weeks, analysts have flagged the rising risk of a recession in the United States as the Federal Reserve aggressively rolls back its ultra-accommodative to tame the rising inflation.

Bank of America’s chief investment strategist Michael Hartnett in a note to clients said that ‘inflation shock’ is worsening & that the ‘rates shock’ is just beginning. The Fed had signalled that it will likely start culling assets from its $9 trillion balance sheet at its meeting in early May and will do so at nearly twice the pace it did in its previous “quantitative tightening” exercise as it confronts inflation running at a four-decade high.

Pandemic-era stimulus and increased savings meant that the demand scenario in the United States was relatively better than in India, which is yet to see a robust, secular demand recovery.

“Unlike the US, the Indian economy is not overheating. We haven’t seen demand fully recover in many sectors so we are seeing inflationary pressures despite there being on aggregate, slack in the economy. Our view is that pandemic led to certain supply-side destruction. Many changes took place during the pandemic which are leading to inflation despite the slack,” Varma added.

When the first wave of the Covid-19 pandemic broke out and a nationwide lockdown was imposed to curb the spread of the disease, India saw one of the deepest recessions in the world, with GDP declining by as much as 23.8% in Q1FY21.

Against this backdrop, the Reserve Bank of India, like its peers, opted for a loose monetary policy to support growth. But external issues, largely, meant that inflation crept up quietly even as the economic recovery remained patchy, making way for a rise in household inflation expectations.

“The other important reason is (for higher inflation) the higher commodity prices along with some supply-side issues created during the pandemic. For India, I think the role of inflation expectation is quite important. Crue and fuel in particular do drive inflation expectations. We have not seen the kind of demand recovery we would have liked,” Varma said.

Analysts feel that the recent move by the RBI Governor Shaktikanta Das to prioritise inflation over growth has meant that policy normalisation has commenced in India.

Nomura is expecting retail headline inflation in India to stay above the mandated target of 2-6% for the most part of FY23. “The trade-off for the RBI is only going to get more complicated and faster tightening from Fed is negative on the external sector but even on the domestic front, tightening tends to be bad for investment-related growth,” Varma said.

In its April 2022 Bulletin, the RBI compared today’s situation with the 1970s. “Although the situation today is significantly different from the oil shocks of the 1970s, the energy markets are global and price waves find their way around the world. Household spending could be sapped and the risk of a recession could intensify,” the report said.