Do it yourself

 The events of the past two months clearly point towards deteriorating global growth prospects; rising economic uncertainties; and widening geopolitical and trade conflicts. Market participants ought to take note of these dark clouds gathering on the horizon.

Deteriorating global growth prospects

The US economy flirting with stagflation

The US Federal Reserve cut its target interest rate by 25bps to 4%-4.25% last week, after a pause of nine months. The fed officials now estimate two more cuts in the next three months. The Fed decided to continue reducing its securities holdings (Treasury, agency debt, agency mortgage-backed securities) as part of its balance sheet runoff.

·         Economic growth has moderated in the first half of the year. Consumer spending is weaker; and housing remains weak.

·         Core inflation is still above the Fed target. The Fed Chairman, Jerome Powell, described the rate cut decision as a risk management measure. He admitted that there is tension between the goals of maximum employment and stable prices; because inflation remains too high while employment risks are rising.

·         In the Fed's opinion, downside risks to employment have increased. There is more concern about labor market weakness than before. Unemployment has edged up (around 4.3% in August). Job gains have slowed significantly. Reportedly, workers out of work for 27 weeks or longer – rose to 1.9mn in August 2025, up 385,000 from a year earlier. These workers now make up 25.7% of all unemployed people, the highest share since February 2022. Persistent long-term joblessness often signals deeper cracks forming in the labor market. Initial claims for unemployment insurance jumped by 27,000 to 263,000 for the week ending Sept. 6.

Most experts believe that under the current circumstances, the Fed may not venture into aggressive easing. QE may not be a viable option given the inflation concerns and aggressive rate cuts may also not help.

Chinese economy facing slow down amidst structural challenges

China has been a major growth engine for the global economy in the past couple of decades. The engine has been showing distinct signs of fatigues in the post Covid period. The Chinese economy grew 5.3% in the first half of 2025, with 5.4% in Q1 and 5.2% in Q2. Industrial output and fixed‐asset investment are weakening. Retail sales / consumer spendings are soft. Property sector continues to drag the economy. Deflationary pressures are mounting.

Growth is widely forecasted to continue slowing, especially in H2 2025, unless strong policy stimulus revives private spending. Some forecasts expect Q3 and Q4 growth to dip below 5%, possibly closer to 4%. Inflation (especially producer and export prices) being weak is threatening to turn into a wider deflation risk. Real estate sector remains a key risk area — both for financial stability and for overall growth.

Structural challenges

·         China’s historical growth model that is heavily reliant on investment, exports, and property, is hitting diminishing returns. Slower labor force growth, aging population, and less efficiency gains also poses a serious structural challenge to the Chinese economy.

·         Tightening financial regulations on developers, falling property prices, and declining real estate investment is feeding into weaker household wealth and local government revenues.

·         After COVID-19 disruptions and regulatory uncertainty, households demand remains weak and not showing much sign of an imminent recovery.

·         Trade tensions (tariffs etc.), shifting global demand, and competition. Export growth has helped in some months, but exports to certain markets have dropped sharply.

European economy showing no signs of improvement

The economic growth in Europe continues to be weak. The European Commission’s Spring 2025 forecast projects ~1.1% growth for the EU overall, and about 0.9% growth in the euro area for 2025 — roughly flat compared to 2024. The deflationary pressures are intensifying. Inflation is expected to drop from ~2.4% to ~2.1% in the euro area in 2025, and further in 2026. Business sentiment in the European economy is weakening, especially among firms exposed to export competition, global trade tensions, and supply chain disruption.

The factors impacting European growth are both cyclical and structural. Therefore, some rebound is expected in 2026, especially if investment picks up and disinflation completes, possibly helping consumer real incomes. However, there is less visibility about improvement in structural factors, in the near term.

Cyclical factors

·         After the Russian invasion of Ukraine, energy supply disruptions (especially natural gas) plus high energy prices raised costs for both producers and consumers. Though prices have retraced somewhat, energy components of costs are still significantly higher than pre-pandemic in many places.

·         To fight inflation, central banks have raised rates. That increases borrowing costs, weighs on investment (especially in manufacturing, construction), and slows demand.

·         Tariffs and trade policy uncertainty (both with the U.S. and more broadly) are hurting export demand.

·         Consumer confidence remains fragile: households are still dealing with high inflation (food, energy), rising living costs, and economic uncertainty. That reduces spending.

·         Investment cycle is not picking up due to higher cost of capital, uncertain regulatory / policy environments, and energy & supply risks.

Structural factors

·         Competition from Asia and China (especially low-cost manufacturers) is squeezing European exporters.

·         Shifts in supply chains and demand patterns post-COVID are disrupting traditional trade flows.

·         Productivity growth has been sluggish in many European countries, as demographics are worsening and investment in tech innovation has been lagging.

·         Regulatory burdens, fragmented capital markets, and slower innovation are holding back private investment and scaling up.

·         High energy costs and environmental transition costs also pose competitive disadvantages relative to regions with cheaper energy or more efficient infrastructures.

·         Civil unrest in many major European economies is becoming more deep rooted with rising resentment against immigration policies and rising youth employment.

Japanese economy also facing specter of stagflation

Japan’s economy recently contracted (-0.2% in a recent quarter), largely driven by falling exports. Demand from major trade partners is weakening. U.S. tariffs on Japanese goods (especially autos and parts) are hurting its export-heavy industries. Inflation has remained above the Bank of Japan’s target (2%) for some time. Food, energy, and import costs (exacerbated by a weak yen) are contributing to higher consumer prices. Moreover, while inflation is persistent, wage growth has been slower, so real income gains are modest.

Growth is expected to remain modest. Most forecasts point to ~1.0-1.2% real GDP growth in FY2025, assuming global demand holds and domestic consumption strengthens. Fiscal pressures continue to mount as interest costs are rising; resulting in less fiscal space for stimulus or cushioning shocks. External risks (trade, global slowdown, currency fluctuations) also remain elevated. For example, stronger yen is hurting exports; and U.S./China trade policies are adversely impacting demand for Japanese goods.

Two major constraints for the Japanese economy are:

Demographics & labor constraints: Japan’s population has been aging fast, and the working-age population is shrinking. This means fewer workers, more spending on healthcare/pensions, and fewer taxpayers. Labor shortages in certain sectors are putting upward pressure on wages, but this comes with trade-offs (cost pressures for businesses, especially smaller firms).

Monetary Normalization: The Bank of Japan has begun to shift away from ultra-loose monetary policy (e.g. raising short-term rates to ~0.5%, reducing purchases of government bonds / ETFs). This helps combat inflation, but carries risks: higher borrowing costs for companies and government, and stress for debtors.

These two are mostly structural and may keep the growth rate of the Japanese economy under check.

…to continue tomorrow.

Global economy

The year 2020 witnessed the global economy contracting by 3.5%, the worst peacetime performance after the great depression. IMF has recently forecasted a “strong” (5.5%) revival in 2021 and “normalization” (4.2%) in 2022. Which essentially means the global economy would be growing at less than 1% CAGR over two years (2020-2021). This rather long pause in global growth means serious setback to the development goals of poverty elimination, climate change and inclusion. The fact that this “pause” in growth could only be achieved with trillions of dollars in fiscal and monetary stimulus, highlights that the legacy of global financial crisis (GFC) and subsequent quantitative easing might have materially weakened the growth drivers of the global economy in past few decades, e.g., development of human capital, globalization of trade and commerce, poverty alleviation, productivity growth, etc.

The new global survey of 295 economists from 79 countries, commissioned by Oxfam, reveals that 87 per cent of respondents, including Jeffrey Sachs, Jayati Ghosh and Gabriel Zucman, expect an "increase" or a "major increase" in income inequality in their country as a result of the pandemic. (see here)

In Indian context, IMF is now forecasting a contraction of 8.5% for FY21 and a growth of 11.5% for FY22. This implies, like global economy, Indian economy would also be growing at less than 1% CAGR over two years (2020-2021). This “pause” in growth over two years comes at the expense significant fiscal leverage (rs30trn stimulus), and massive liquidity infusion.

The latest Oxfam report highlights that the pandemic induced lockdown may resulted in massive rise in socio-economic inequality. While the formal sector workers mostly escaped unscathed or with small salary cuts; the job losses in informal sector were massive. “Out of a total 122million people who lost their jobs, 75%, which accounts for 92million jobs, were lost in the informal sector. The disruption in school schedules may result in massive rise in school dropout young population, further widening the socio-economic abyss.

As per Oxfam, "Only 4% of rural households had a computer and less than 15% rural households had an internet connection. Only 6% of the poorest 20% has access to non-shared sources of improved sanitation, compared to 93.4% of the top 20%.

Global Trade

IMF sees global trade rising by 8.1% in 2021, after an estimated 9.6% decline in 2020. The rebound is much weaker, as compared to post global financial crisis (GFC) rebound in 2010-2011. The recovery would look even insipid if we factor in poor trade growth during 8yrs preceding the pandemic (2012-2019).

In a recent update, ING Bank highlighted—

“With freight rates signaling capacity constraints in world trade, it’s likely that trade volumes won’t be able to rise much further – even to serve catch-up demand – when countries emerge from the second wave of lockdowns. Capacity may only come back on stream slowly as shipping liners wait until the global recovery is more firmly underway before bringing back inactive ships. Even then, containers being unavailable where they are needed will drag on volumes for some time. Capacity constraints mean that trade volumes won’t be able to rise much further even when countries come out of lockdowns

In the near term, limits to global trade growth are likely to be a modest headwind for GDP compared to the far more disruptive domestic lockdowns. More important will be higher freight rates and import prices building inflationary pressures over the course of the year.”

The present state of global economy and trade is therefore far from Blue Sky; even though the dark clouds may have dispersed for now. A bullish bet on sustainable global recovery to beyond “Pre Covid sub optimal levels” might be premature as of this morning, in my view.

A sharp rise in inflation, as presently anticipated by a section of global economists and investors, forcing monetary tightening; could however lead even the recovery to Pre Covid level, halting in its strides.