'Price rise may be persistent as it has moved into core inflation in Asia'

The International Monetary Fund (IMF) recently released a regional economic outlook (REO) on Asia and Pacific, in which it cut the growth projections for the region. The IMF’s Asia Director Krishna Srinivasan tells Indivjal Dhasmana that central banks in the region have to tackle inflation head on because fiscal measures can only provide short-term relief. Edited excerpts:

The IMF has cut Asia and Pacific region’s economic growth projections for 2022 and 2023 due to external factors. Which of the factors is a bigger cause for concern — the Russia-Ukraine war, worsening property market in China, or monetary policy tightening by central banks in the developed countries?

The IMF cut the region’s economic growth projections to 4 per cent for this year and 4.3 per cent for the next year. This is about one percentage point cut from our April forecast. Some of the risks we had presaged in April have become magnified.

The first is that financial conditions have tightened across advanced economies, which has significant bearings on Asia. This has also led to capital outflows from the region. The second is the Russia-Ukraine war. This had a significant impact in April through an increase in commodity prices. The last was China, which is more for the region. Growth there is now projected at 3.2 per cent this year and 4.4 per cent next year. Slowing growth in China has significant bearing on the region.

If these risks intensify, it would be even worse for the region. For instance, if growth slows in the US by one percentage point due to tightening, the region’s growth would be 3.3 per cent next year.

If there is indeed a recession in developed countries, how would it affect Asia and Pacific?

Any kind of slowdown in the advanced world will have a significant impact on the region. We have done some work in the past that shows that if the growth slows by one percentage point in the advanced world, growth in Asia and Pacific would slow down by 0.5-1 percentage point. This is because the US and Europe are the biggest export markets for the region.

What is the possibility of stagflation in the advanced world and how severe will its impact be on Asia and Pacific?

The report talked about slowing growth and elevated inflation in the advanced world. It is not a stagflation, but a stagflation-like situation. The difference between this and the wage price spiral of the 1980s is that the risk of the latter has reduced. Now, central banks are a lot more credible. They have a credible inflation-targeting framework. Because of that we don’t see the risk of wage price spirals. That said, inflation is still a bit of concern in these countries and that is the reason many of the central banks continue to tighten monetary policy quite rapidly, which has implications for monetary policy in Asia and Pacific.

You talked about inflation. How do you see inflation panning out in Asia and Pacific?

In 2021, inflation was relatively muted in Asia due to good harvest in India, swine flu, and not too high rice prices. In 2022, inflation has risen especially after the Russia-Ukraine war began. Going beyond that, we have seen that inflation in Asia and Pacific has risen beyond the headline numbers into core inflation in almost all major countries. As a result, all central banks in the region, except China and Japan, have tightened monetary policy. So inflation is the key concern that needs to be addressed head on by central banks in the region.

You are saying that core inflation is a concern now. How severe is it?

Core inflation is rising because there is a pass-through from headline to core inflation. More importantly, core inflation is persistent. So, it does not come down rapidly. Secondly, pass-through inflation is higher now than in the past. As a result, inflation is likely to be higher in the long run.

Do central banks have innovative tools that could contain inflation without sacrificing growth?

In some countries, they have tried to use fiscal subsidies to dampen prices. But those are not sustainable because at the end of the day they will have short-term impact. But if the underlying inflation is strong then the fiscal cost of those measures can rise. It can have a palliative impact in the short term, but it is not a long-term solution. So, even those countries have stepped back from such subsidies and tightened monetary policy.

India has also extended the free foodgrain supply scheme to 800 million people by three months. Do you think it will have to be withdrawn after this period?

Let us not forget that we have had back-to-back crises. We had the pandemic, and then the war. So, governments want to help those who have been hurt. What we are advocating is targeted support so that the fiscal impact is not huge. We are also saying it can be done in the context of a neutral budget to the extent possible by cutting expenditure somewhere else. This needs to be done because the debt level in Asia has also risen.

The IMF has also called for restoring a fully functional WTO dispute resolution mechanism. Doesn’t it look ambitious in these days of regional agreements?

One has to look at these issues from a longer-term perspective. After the setting up of the WTO dispute resolution mechanism in 1995, 600 cases were brought before it. Those days members had faith in this mechanism. One can do better to ensure that this works. In the recent past, the US has shown greater willingness to work with other members in improving this mechanism and that, I think, is the right way to proceed.

The report also talks of keeping each regional agreement open to participation by others willing to take similarly ambitious obligations. Is that not out of sync with reality?

When two or three countries come together and form a trade agreement, it all depends on them whether they want to keep the option to allow other countries open. That is something one would like to believe that they would want to have. At the end of the day, the more countries that join trade agreements the better off you are in terms of greater trade among countries.

The IMF has cautioned economies in Asia and Pacific against resorting to protectionist measures. In this context, how do you view production-linked incentive (PLI) schemes in India?

These schemes do not discriminate against foreign and domestic investments. These are specifically targeted at improving investments in 13 sectors in India. The fiscal cost of the schemes is reasonable. One has to wait and see how these pan out.