Vijay Kumar Gaba

 Last week I  had written (see here) about how the fourth letter of the English Alphabet “D” has gained prominence in the financial market jargon. In particular, I find three “Ds”, viz., Digitalization, Deflation and Demographics most relevant for the economy and therefore markets.

A recent speech of Dr. Michael Patra, Deputy Governor of RBI, as published in the latest monthly bulletin of RBI (May 2023), highlighted some more ‘D” factors that are ushering India into a new age. Besides demographics & Digitalization, Mr. Patra emphasized on Diaspora, Diversification, Diplomacy, Dynamic Federalism, and Decarbonization as key factors in transformation of the Indian economy. The following are some excerpts from his speech:

Diaspora: An outward reflection of India’s demographic bonus is the vibrant expansion of Indian communities across the world. Over the years, our perceptions about the diaspora have also transformed from ‘brain drain’ to ‘brain gain’, spurred by the contributions that Indians have made in various fields in the global arena, including information technology, entrepreneurship, international politics, medicine, arts and culture, with some of them becoming Nobel laureates. It is estimated that over 90 out of 1078 founders of about 500 unicorns in the US are persons of Indian origin.

The Indian economy has been a beneficiary of this dynamic and industrious diaspora. India currently receives the highest flow of remittances in the world at US $ 108 billion in 2022, up by 24.6 per cent from a year ago, and accounting for 3 per cent of India’s GDP. Additionally, Indians residing abroad hold deposits in Indian banks cumulating to US $ 136 billion at the end of February 2023.

Diversification: The Indian economy is undergoing a quiet but fundamental transformation encompassing all its sectors. Perhaps the most striking transformation is occurring in India’s exports of services which have demonstrated pandemic-proofing, rising by above 25 per cent per annum since 2020, and providing valuable support to the viability of the external sector. While software and business services are the main drivers of this robust performance, advances in IT have not only made services more tradable but also increasingly unbundled: a single service activity in the global supply chain can now be fragmented and undertaken separately at different geographical locations. Jurisdictions have accordingly been decentralising and diversifying their supply chains to ensure business continuity. These factors have led to a new channel of IT-enabled services - large multinational corporations (MNCs) are setting up Global Capability Centres (GCCs), which are offshore offices, delivering a wide array of services across IT sector verticals.

India is also becoming a hub for engineering R&D (ER&D) centers as leading multinationals develop their centers of excellence (CoEs) across different business domains. The National Association of Software and Service Companies (NASSCOM) estimates that India will add 500 GCCs by 2026. They are going to be hiring. India’s citizens of the future should prepare for this revolution. The world is coming to our doorstep to fill world-class jobs.

Diplomacy: India is prioritising a reformed multilateralism that creates a more accountable, inclusive, just, equitable and representative multipolar international system for the 21st century. Our priorities include addressing the macroeconomic implications of food and energy insecurity; climate change; strengthening Multilateral Development Banks (MBDs); debt sustainability; strengthening financial resilience through sustainable capital flows; financing inclusive, equitable and sustainable growth; leveraging digital public infrastructure; climate financing; and opportunities and risks from technological change.

Dynamic Federalism: Increasingly, the quality of life and the business environment in India is going to be defined by shifts in the focus of public policy that foster competitive federalism among India’s states in achieving the aspirational goals of sustainable economic development. The freedom to compete allows each state to design, experiment, innovate and reform, given its unique features and challenges, while emulating best practices achieved by peers. An example of the power of competitive federalism is the drive among states to attract private investment, both domestic as well as foreign, by showcasing investment opportunities in each state. The spirit of competitiveness is being promoted at the highest policy levels.

As our states compete for a place in the sun, they will nurture business growth, put in place the best physical and social infrastructure and provide us with improved basic amenities, clean energy, and better health and societal outcomes. Along with foreign investment bringing in new technologies and ideas, we are moving into a national ethos of wider consumer choices and a better standard of living.

Decarbonisation: India and other developing economies are highly vulnerable to climate change due to their limited capabilities in climate science and technology and insufficient funding for adaptation and mitigation. The relative costs of transitioning to a greener path are higher for them than for the advanced economies; undertaking the transition can even push them several places down the development ladder. From the developing world, India has emerged as a leading voice on global climate action that is mindful of climate equity and justice considerations.

India has co-founded the International Solar Alliance (ISA) with France in 2016 and announced a National Hydrogen Mission to increase the dependency on green energy. The Mission LiFE, i.e., Lifestyle for the Environment, launched in 2022, is now a global movement to connect the powers of the people for the protection of the earth.

Dr. Patra ended his speech by invoking Victor Huge’s words- ““Nothing else in the world…not all the armies…is so powerful as an idea whose time has come.” He, like millions of us, too believes that India’s time has come and we must seize it. There are formidable trials and challenges ahead, but they can be overcome if we exploit the comparative advantages.

Recently the government of India launched Mission LiFE (Lifestyle for Environment). The Mission is “designed with the objective to mobilise at least one billion Indians and other global citizens to take individual and collective action for protecting and conserving the environment in the period 2022–28. Within India, at least 80 percent of all villages and urban local bodies are aimed to become environment-friendly by 2028.”

 The US Federal Reserve has comforted the global markets with assurance of maintaining strong intent to control prices while not being unnecessarily disruptive in terms of monetary tightening. The markets are apparently reading a 0.9% contraction in the US economy in 2Q2022, as sufficient ground for the Fed to be mindful of the likely disruptive impact of the future hikes; given that the US economy is technically in recession after having contracted for two consecutive quarters in 2022.

The marked slowdown in the economic activities in Europe and China; and easing of the global logistic bottlenecks has noticeably moderated the inflationary expectations, as reflected in the yield curves across the globe. The fears of 1930s type hyperinflation appear to have subsided, at least for now. The equity valuations are gradually adjusting to “above zero” and “neutral” interest rate regimes. The recognition of “positive rates” however is still missing from the popular narrative and hence remains a key risk.

The wider acceptance of the ground realities in respect of the Russia-Ukraine conflict is making it relatively easier to find amicable supply chain solutions. Gradually, the global community is beginning to accept that (i) the conflict may persist for longer than previously anticipated; (ii) stricter economic sanctions on Russia may not yields the desired results and in fact could produce material unintended consequences; and (iii) isolating Russia could provide significant impetus to the ideas of “de-globalization” and “polarization” of the world; raising the specter of multiple and larger geopolitical conflicts, and undermining the global consensus on important issue like climate change, poverty alleviation and denuclearization.

Two factors that can impede the process of returning to normalcy (yet a New Normal), in my view, are –

(1)   Compromise on the climate control targets, further aggravating the already erratic weather conditions across the globe.

The food shortages (and consequent food inflation) could worsen materially leading to reversal of advancements made towards poverty and starvation alleviation in the past three decades in particular. There could be widespread civic unrest; production and supply chain disruptions; and rise in loss of human lives due to hunger, violence and inclement weather.

(2)   Dominance of leftist ideology in global politics hampering creation of new capacities and perpetuating inflation.

As I had mentioned in one of my earlier posts (The Challenges of economic policy), a large number of countries are opting for left of center parties/leaders to govern them. Moreover, to counter the egalitarian agenda of left of center parties, even the right of center parties like conservatives in UK, BJP in India, LDP in Japan and Yemina in Israel are increasingly resorting to socialist agenda to retain power. Obviously, the top priority of governments across the world is immediate relief to the poor rather than growth. It is therefore more likely that the tighter monetary and fiscal conditions will continue to challenge the growth ecosystem in near future. The new capacity building may continue to lag; resulting in more frequent bouts of high inflation, as compared to the past two decades and hence larger volatility in financial stability and macroeconomic environment.

In the latest episode of global inflation, ‘climate change’ is one of the key players. It has significantly impacted the supply and demand equilibrium of many commodities and services in a variety of ways. For example—

(a)   Notable changes in weather patterns have adversely impacted the crop production and livestock supply globally, resulting in sustained rise in food prices.

(b)   The global commitment to fight climate change has resulted in a significant rise in investment in clean energy and clean technology; mostly at the expense of investment in conventional energy. Most countries are aiming to achieve ‘zero emission’ in the next 3 to 4 decades. In the transition period, obviously the supplies of conventional energy shall remain constrained for the lack of adequate investment, tilting the scale in favor of higher prices. Sharp surge in coal and crude oil prices (even adjusted for logistic challenges due to Covid) is indicative of this.

(c)    The focus on clean energy and clean technology has resulted in an immediate rise in demand for non-ferrous metals, silicon, rare earths, semiconductors; whereas the additional capacities will come in due case as new investments are committed. Covid may have pushed the capacity building process further by 3 to 4 years. The demand pull inflation in these commodities and products may also sustain for some more time.

(d)   ‘Climate change’ and the efforts to control/reverse the adverse effects of climate change are resulting in significant displacement of labor in many areas, resulting in demographic imbalances besides demand-supply mismatch.

The farmers displaced due to adverse weather conditions due to climate change are struggling to get employment.

The skill requirements for the jobs lost in the ‘carbonized ecosystem’ and jobs being created in the ‘clean ecosystem’ are very different.

As per a recent McKinsey report, to achieve ‘net-zero’ by 2050, the capital spending on physical assets for energy and land-use systems will need to rise by $3.5 trillion per year for the next 30 years to US$9.2trn/year. The cumulative capital spending on physical assets for the net-zero transition between 2021 and 2050 would be about $275 trillion. A net-zero transition would have a significant and often front-loaded effect on demand, capital allocation, costs, and jobs.

The report highlights - (i) The transition would be felt unevenly among sectors, geographies, and communities, resulting in greater challenges for some constituencies than others. Developing countries and fossil fuel-rich regions are more exposed to the net-zero transition compared with other geographies; and (ii) As high-emissions assets are ramped down and low-emissions ones ramped up in the transition, risks include rising energy prices, energy supply volatility, and asset impairment.

The points to ponder, inter alia, are (i) whether the global economy is prepared and willing to tolerate the pain of transition for 20-30 years; or efforts would be made to find a balance by allocating adequate capital to conventional energy and technologies; especially hydrocarbons and food production; and (ii) who will bear the losses as trillions of dollars in extant assets become redundant? 

 The latest edition of the World Economic Forum’s global risk report (The Global Risk Report 2022) offers some valuable and interesting insights into the current global risk perceptions and areas of concern. The key message is that “A divergent economic recovery from the crisis created by the pandemic risks deepening global divisions at a time when societies and the international community urgently need to collaborate to check COVID-19, heal its scars and address compounding global risks.”

The clear and present global challenges include “Supply chain disruptions, inflation, debt, labour market gaps, protectionism and educational disparities are moving the world economy into choppy waters that both rapidly and slowly recovering countries alike will need to navigate to restore social cohesion, boost employment and thrive. These difficulties are impeding the visibility of emerging challenges, which include climate transition disorder, increased cyber vulnerabilities, greater barriers to international mobility, and crowding and competition in space”. To meet these challenges, the world needs trust and cooperation within and between countries, lest the world shall continue to drift apart.

Risk Perception of global managers

Results of the Global Risks Perception Survey, that underpins the report, highlight the following key sentiment indicators:

·         Most respondents see social risks in the form of “social cohesion erosion”, “livelihood crises” and “mental health deterioration” continue to worsen.

·         Frighteningly, “only 16% of respondents feel positive and optimistic about the outlook for the world, and just 11% believe the global recovery will accelerate. Most respondents instead expect the next three years to be characterized by either consistent volatility and multiple surprises or fractured trajectories that will separate relative winners and losers.”

·         The societal and environmental risks are seen as the most concerning for the next five years.

·         However, over a wider horizon of next 10 years, health of the planet dominates concerns;  with “climate action failure”, “extreme weather”, and “biodiversity loss” ranking as the top three most severe risks. “Debt crises” and “geoeconomic confrontations” are seen as among the most severe risks over next 10 years.

·         Technological risks—such as “digital inequality” and “cybersecurity failure”—are seen as the other critical short- and medium-term threats to the world.

·         About the present risk mitigation methods and techniques, the global risk managers believe that “the current state of risk mitigation efforts fall short of the challenge in areas like “Artificial intelligence”, “space exploitation”, “cross-border cyber-attacks and misinformation” and “migration and refugees”. The present risk mitigation efforts are seen as effective in facing the established risks such as “trade facilitation”, “international crime” and “weapons of mass destruction”.

Climate Action Failure – top most long term risk

The failure in addressing the climate concerns is perceived as “the number one long-term threat to the world and the risk with potentially the most severe impacts over the next decade. It is highlighted that the “Climate change is already manifesting rapidly in the form of droughts, fires, floods, resource scarcity and species loss, among other impacts. In 2020, multiple cities around the world experienced extreme temperatures not seen for years—such as a record high of 42.7°C in Madrid and a 72-year low of -19°C in Dallas, and regions like the Arctic Circle have averaged summer temperatures 10°C higher than in prior years.

It is evident that “Governments, businesses and societies are facing increasing pressure to thwart the worst consequences. Yet a disorderly climate transition characterized by divergent trajectories worldwide and across sectors will further drive apart countries and bifurcate societies, creating barriers to cooperation.”

Cyberthreats emerging as prominent risk

As per the Report, “in 2020, malware and ransomware attacks increased by 358% and 435% respectively—and are outpacing societies’ ability to effectively prevent or respond to them. Lower barriers to entry for Cyberthreats actors, more aggressive attack methods, a dearth of cybersecurity professionals and patchwork governance mechanisms are all aggravating the risk.”

It is anticipated that “attacks on large and strategic systems will carry cascading physical consequences across societies, while prevention will inevitably entail higher costs. Intangible risks—such as disinformation, fraud and lack of digital safety—will also impact public trust in digital systems. Greater cyberthreats will also hamper cooperation between states if governments continue to follow unilateral paths to control risks. As attacks become more severe and broadly impactful, already-sharp tensions between governments impacted by cybercrime and governments complicit in their commission will rise as cybersecurity becomes another wedge for divergence—rather than cooperation—among nation-states.”

“Involuntary migration” poses a potent risk

Economic hardships, climate change and political instability in many countries is forcing a lot of people to migrate to safer places involuntarily. At the same time, effects of pandemic and other factors are resulting in increased economic protectionism and restrictive labor markets, creating higher barriers to entry for migrants. “These higher barriers to migration, and their spill-over effect on remittances—a critical lifeline for some developing countries—risk precluding a potential pathway to restoring livelihoods, maintaining political stability and closing income and labour gaps.”

In the most extreme cases, humanitarian crises will worsen since vulnerable groups have no choice but to embark on more dangerous journeys.

It is noteworthy that “the United States faced over 11 million unfilled jobs in general and the European Union had a deficit of 400,000 drivers just in the trucking industry.”

Space could be new war zone

The report mentions that ‘New commercial satellite market entrants are disrupting incumbents’ traditional influence over the global space commons in delivering satellite services, notably internet-related communications. A greater number and range of actors operating in space could generate frictions if space exploration and exploitation are not responsibly managed. With limited and outdated global governance in place to regulate space alongside diverging national-level policies, risks are intensifying.”

“One consequence of accelerated space activity is a higher risk of collisions that could lead to a proliferation of space debris and impact the orbits that host infrastructure for key systems on Earth, damage valuable space equipment or spark international tensions.”