Macrovariable Estimates in Uncertain Time

The Fed has again raised its benchmark interest rate by 0.75%. The Reserve Bank of India has also been forced to raise interest rates further but other steps have also been taken. These decisions at the Monetary Policy Committee (MPC) meeting, MPC members see as the likely course of the economy in the coming months. But, the trajectory of the world economy and its potential impact on the Indian economy, is impossible. Therefore, Indian policy makers will face two important problems.

First, the main uncertainty is due to Russia’s war on Ukraine And the resultant economic sanctions on Russia, as well as a zero-COVID-19 policy in China that enforces repeated lockdowns causing global supply bottlenecks. Second, the policy has to be based on data. If it is lacking, it introduces additional uncertainty, making projections for the future difficult and causing policies to fail. This will further exacerbate the problem arising as a result of global uncertainty.

stagflation and disease

Since the beginning of 2020, the SARS-COV-2 virus has caused global uncertainty. The waves of COVID-19 have curtailed human activities with resultant loss of production. Different countries have implemented lockdowns of varying severity, leading to supply bottlenecks. In a globalized interdependent world, production is affected resulting in price rise (inflation) and loss of real income. This has resulted in a fall in demand and in a vicious circle, further slowdown of the economy. These declines have been difficult to predict because it is difficult to predict when another wave will occur and how much disruption there will be. As global prices have risen and economies have slowed, many countries have experienced stagflation.

Uncertainty due to novel coronavirus Despite persistence of attack waves, there has been a decline as new virus mutants of the virus have a milder effect and immunity due to vaccination. Countries are no longer enforcing lockdowns so strictly, in turn reducing the adverse economic impact.

However, China is an exception with its zero-COVID policy. It has been enforcing a strict lockdown over the past six months, even when only a few cases of the disease have been detected. Since China is now the manufacturing hub of the world, any disruption affects supplies globally and bottlenecks remain.

Now there is another issue. monkeypox virus It has emerged suddenly in the past few months and has rapidly spread to more than 80 countries where it is not endemic. The World Health Organization is confident that this threat is more easily dealt with than COVID-19. Still, anxiety and uncertainty have mounted.

Ukraine conflict

The war in Ukraine and Western sanctions on Russia have caused enormous uncertainty since February 2022 (when Russia invaded Ukraine) and displaced the uncertainty related to the disease, i.e., COVID-19. This is because the war is a proxy war between two powerful capitalist factions. They are strong both militarily and financially. While Russia invades Ukraine, Western powers are supplying weapons to prolong the war and weaken Russia. At the same time, sanctions on Russia are being used to weaken it economically.

Neither side can be seen as losing. Thus, conventional warfare may turn into a different and more intense war. Thus, unless a solution is found soon, the uncertainty will remain huge and will likely increase. The inexplicable suffering of the people of Ukraine from the bombing of cities continues, and it may increase.

Wars and sanctions have already affected the world economy, and Europeans in particular. The US economy has entered a technical recession, with GDP declining by two-quarters. Sri Lanka is devastated and many other developing economies like Pakistan and Nepal are in crisis. Prices have risen as supplies of vital commodities from Russia and Ukraine were hit. Europe, the United States and India have experienced or are experiencing high inflation.

The biggest disruption in energy supply from Russia is affecting production. Availability of food, fertilisers, metals etc has been affected as Ukraine and Russia are important sources. Thus, the already prevailing high inflation due to the pandemic is exacerbated by wars and sanctions. Since the end of the war and sanctions are uncertain, these problems are likely to persist.

a new cold war

Even though the war is over, a new cold war has begun between the two big blocs, namely Russia and China on one side and rich nations on the other. To weaken Russia, sanctions can be imposed on countries doing business with it. Many Indian entities may face heat as India increases its imports from Russia, which weakens sanctions. China may also face sanctions as it has increased trade with and is supporting Russia. China has no choice but to go with Russia as Western powers are trying to isolate it for fear of its global rise.

In short, the global economy will continue to be affected in the near future due to war, sanctions and a new cold war between the two major economic blocs.

data concerns

As if the uncertainty from global factors weren’t bad enough, Indian policymakers also face issues related to data. Not only is it available on most macroeconomic variables with a large lag, but for many variables, the data is either not available or contains large errors.

Policy makers rely on high frequency data to proxy for actual data. For example, there is very little data available for quarterly GDP data which is used to calculate the growth rate of the economy. First, data for the unorganized sector is not available except in agriculture. Second, there is very limited data available for the organized sector. Third, estimates or proxies from the previous year are used – both of which introduce errors when the economy has been hit by repeated shocks, such as pandemics and now wars.

Price data are also problematic. The service sector is under-represented. The prices of many services have increased and expenditure on them has increased dramatically, thus changing their weight in the consumption basket. For example, the cost of health and education increased during the pandemic. Also, the impact of the black economy has not been included.

Moreover, the consumer price index for the upper class and the poor is the same. The former consume a small portion of their income, so they hardly feel the pinch of inflation. The poor consume almost their entire income and have no cushion to increase their expenditure in line with the rise in prices. So they have to reduce their consumption. Earlier, there was a separate index for different categories of people, which reflected the differential effect of inflation on the people. It presented a true picture of the crisis of the economy and the people.

The unorganized sector, which employs 94% of the workforce, has been badly hit by the fall in income and rise in prices over the years. It does not have bargaining power to increase its wages as prices rise and, therefore, loses purchasing power. The data does not reflect this and the unorganized sector becomes ‘invisible’.

Policy makers who use such faulty data make them invisible. If the economy is growing at 7.5% and inflation is below the Reserve Bank of India’s tolerance level of 6%, policy makers assume all is well. There is no need to do anything special for the unorganized sector. But estimates turn out to be wrong (as has been the case in recent times) when policymakers predict economic turnaround and low inflation. Even faulty official figures do not confirm this.

Indian policy makers are faced with the incredible task of predicting the course of the economy for the next few months and even the coming year (or years) due to setbacks and faulty and insufficient data. The problem is compounded by international factors. Will the war on Ukraine end soon? And if not, will it be faster? Will the restrictions be lifted? How intense will the new Cold War be? All this makes estimates of macrovariables – GDP, inflation, balance of payments, etc. impossible and policy makers akin to pilots navigating a thick fog with faulty instruments.

Arun Kumar was Professor of Economics at Jawaharlal Nehru University, New Delhi