For the Indian economy, the haze of uncertainty is growing. The global economy is experiencing one shock after another with every quarter that goes by. India’s economic prospects would be significantly impacted by slowing global growth and high levels of uncertainty in the financial markets, although recent local macroeconomic data that indicates a rather stable home economy.
One of the safest financial investments is thought to be the US bond markets. Global investors are investing more money in the US economy as a result of the increase in interest rates in the US.
Last week, the financial markets plunged into complete meltdown, both in India and globally. The US 10-year bond rates reached 5%, a level last seen in 2007 and the cause of this worldwide sell-off. Three questions arise from the sequence of events.
Since the 2008 Global Financial Crisis, the US economy has been extremely unpredictable. The crisis originated in the US financial markets and quickly expanded to other parts of the world. The Federal Reserve drastically lowered the Federal Funds Rate (FFR), its policy interest rate, to levels close to 0 percent. The Federal Reserve began raising policy rates in 2016 but was forced to do so once again during the epidemic, this time to almost zero. Following the war between Russia and Ukraine, inflation spiked dramatically, forcing the central bank to raise policy rates in the previous year.
Monetary transmission is the foundation of contemporary monetary policy. According to the theory of monetary transmission, changes in policy rates affect interest rates on bonds, deposits, and loans in the financial markets. The yield on the US 10-year bond followed the FFR as well. Between 2009 and 19, the 10-year yield fell from 5 percent in 2007–08 to a range of 2–3 percent. During the pandemic, the yield fell to a level of less than 1%, following the drop in FFR. Following the conflict, as the FFR increases, the 10-year yield suddenly returns to levels last saw in 2007–2008.
To the first question, the 10-year yield has increased as a result of rising policy rates. Although US inflation has decreased from its peak in 2022, it is still more than the 2 percent target inflation rate. Because of this, the markets now anticipate that the Federal Reserve will tighten policy further, bringing inflation back to 2%. In a recent address, Federal Reserve Chair Jerome Powell emphasised that the bank’s goal is to “bring inflation down sustainably to 2 percent.” These comments have only served to validate market predictions of more policy rate increases, which has caused 10-year rates to approach five percent.
In addition to monetary policy, the rates have increased in tandem with the US economy’s high levels of debt and budget deficits. The US economy has consistently had large budget deficits, averaging 6% of GDP, since 2008. The US Total Debt as a proportion of GDP is expected to quadruple from 60% to 120% in 2022 due to the country’s ongoing high deficits. Even earlier, the markets were concerned about the US debt’s escalating trend, but their worries were disregarded because of the low interest rates. The high level of public debt is contributing to rising policy interest rates and high yields.
To the second question, the truth is that capital leaves US markets as US rates rise. One of the safest financial investments is thought to be the US bond markets. Global investors are investing more money in the US economy as a result of the increase in interest rates in the US. The decrease in the equities markets and the depreciation of the currency are caused by capital outflows from other nations. Rising US interest rates also had an effect in 2022, as the depreciation of currencies against the US dollar caused a financial collapse in the UK and Europe.
As of 2010–21, 73 percent of nations have seen slower development than they did ten years ago, up from 44 percent in 2000–10. It is quite possible that the earlier 2010–19 decade would have seen a slowdown in global growth. However, the extremely loose fiscal and monetary policies supported the expansion. There are a lot of tensions in the financial markets and the economy as the days of loose monetary policy are coming to an end. The unwinding of loose monetary policy was another factor contributing to the US financial crisis in the first half of 2023.
The macroeconomic data coming in from within indicates that the domestic economy is comparatively steady. India’s economic prospects would be hampered by the world economy’s decreasing growth and the high level of uncertainty in the financial markets. Increasing oil prices and increased capital flight will make controlling inflation and current account deficits more difficult.
The stock markets will continue to fluctuate in tandem with world events. The Indian economy is the fastest-growing in the world, but to reach the pre-crisis growth levels of 8 percent and higher, it needs the help of global growth. India’s macroeconomic managers will need to keep a close eye out for any new hazards that the global economy may provide.