The challenges in the global economy

The challenges in the global economy

Global economic environment remains challenging. Policy makers must proceed with caution, be mindful of the risks.

On Wednesday, the Indian rupee fell 66 paise, breaching the psychological level of 83 against the dollar. While the fall continued during early trading on Thursday, the currency thereafter pared down its losses. Since the beginning of this year, the currency has fallen by around 12 per cent against the greenback. However, the Indian rupee is not an outlier as currencies of most advanced and emerging economies have fallen. In fact, as some analysts have pointed, broadly speaking the fall has been more severe among currencies of developed economies. The euro and the pound have fallen sharply, while the Japanese yen is hovering around 150 against the dollar — a level not seen in decades. This weakness is unlikely to abate in the near term.

The latest data suggests that inflation is likely to persist in advanced economies. In September inflation stood at 8.2 per cent in the US, 9.9 per cent in the Euro Zone and 10.1 per cent in the UK. While volatile energy prices are in part to blame, core inflation has remained elevated. This would suggest that inflation pressures are unlikely to fall quickly. Central banks in these countries are thus likely to continue to tighten aggressively which will likely lead to further capital outflows from emerging markets. The selling by foreign portfolio investors can be seen in Indian markets as well. For India, a deteriorating current account balance will only complicate matters, exerting further pressure on the currency.

So far, the Reserve Bank of India, like central banks in some other developing economies, has been actively intervening in the currency markets to support the currency. Part of the decline in its foreign exchange reserves – they have fallen from $633 billion at the beginning of the year to $532 billion at the end of October 7 — can be attributed to its interventions. While the pace of decline in the reserves is worrying, they remain “robust” as per global rating agency Fitch, covering 8.9 months of imports in September, higher than during the taper tantrum. The rating agency also argued that the current account deficit will be “contained at a sustainable level”. However, considering that the global economic environment will remain challenging over the near term, policy makers must continue to exercise caution, be mindful of the risks to the economy.