Investors and financial markets express a collective sigh of relief as indications suggest the battle against inflation might be nearing an end, particularly with the Federal Reserve’s anticipated easing of interest rates in the coming year. While inflation is showing signs of slowing in many countries, it remains elevated with variations across different economies and inflation metrics. The accumulation of gas reserves in Europe and a dip in demand from China have significantly reduced energy and food costs from their 2022 highs. Nonetheless, food prices are still higher than usual. These factors, alongside the stabilization of supply chains, have led to a notable drop in headline inflation in numerous countries.
However, core inflation, which excludes volatile food and energy prices, has decreased more slowly and continues to surpass the targets set by many central banks. This sustained inflation can be attributed to various factors, including the delayed effects of previous price shocks, high corporate profits, and robust wage growth amid tight labor markets and sluggish productivity, all contributing to increased unit labor costs. Yet, to this point, there hasn’t been a widespread emergence of wage-price spirals, where wages and prices rise concurrently over an extended period. Additionally, long-term inflation expectations have largely remained stable.
In India, retail inflation has climbed to 5.55% in November 2023, up from 4.87% the previous month. This increase is particularly noticeable in the food and beverage sector, which saw an 8.02% rise. Transport and communication costs, which account for a significant portion of the consumer price basket, also increased by 2.09% in November. Such hikes could potentially trigger cost pressures across various sectors. Conversely, the inflationary trend in housing has shown a slight decrease.
On a global scale, growth is expected to decelerate from an estimated 3.5 percent in 2022 to around 3.0 percent for the next two years. Similarly, world trade growth is likely to fall sharply in 2023 before seeing a modest recovery in 2024, remaining below the average growth rate of the early 2000s. This slowdown is attributed to a combination of factors, including a shift in demand towards domestic services, the delayed impact of the U.S. dollar’s appreciation, and rising trade barriers.
Despite economic rebounds and unexpected inflation surges, public debt has stubbornly remained high. Governments have continued to incur fiscal deficits by increasing spending to stimulate growth and address food and energy price spikes while winding down pandemic-related fiscal support. In recent decades, China has significantly contributed to global debt, with its borrowing rate outpacing its economic growth. The nation now holds a substantial portion of the world’s non-financial corporate debt. Meanwhile, many low-income countries face increasing debt challenges, with a significant number at high risk of or already experiencing debt distress.
Globally, debt levels have seen a notable decrease, but they continue to pose concerns. The decline in public debt has slowed, and private sector debt has made the most substantial contribution to the overall reduction. However, the decrease only partially offsets the dramatic rise during the pandemic, and global debt remains above pre-pandemic levels, indicating a return to the historical upward trend. Addressing these vulnerabilities is crucial.
Geopolitical tensions add another layer of complexity, threatening financial stability through various channels. The imposition of financial restrictions, increased uncertainty, and cross-border outflows could heighten banks’ risks and funding costs, while disrupting supply chains and commodity markets, impacting domestic growth and inflation. These tensions could amplify market and credit losses, reduce banks’ profitability and capitalization, and diminish their risk-taking capacity, leading to reduced lending and further economic slowdown. The impact is likely to be more pronounced in emerging markets and developing economies, and among banks with lower capitalization ratios.
