What can we expect from Union Budget for FY 26?

The imminent arrival of Donald Trump as President of the US has injected enormous uncertainty into the global environment. In such a situation, the Union budget for FY 26 has to be low-key, not overly ambitious and aimed primarily at ensuring the shock waves that Trump is expected to unleash do not destabilise the economy.

My artice in BS, Budgeting in the time of Trump. 

Economic policymaking must always reckon with uncertainty. There are times when the uncertainty is acute. The biggest challenge in recent years was the Covid-19 pandemic. It was hard to tell how long it would last. The policy response to it was, however, quite clear--- fiscal and monetary stimulus, although nations came up with varying degrees of stimuli. 

What looms ahead of the Union Budget for FY26 is, perhaps, even more challenging. Nobody quite knows how the US President-elect, Donald Trump, will proceed with his plans and how other nations will respond.  Also uncertain are his stance on the two geopolitical hotspots at the moment, Ukraine and West Asia, not to mention his own additions, Greenland and the Panama Canal. The only known is that the world economy must brace for major shocks. The focus in the coming Union Budget must be to keep the growth momentum going so that the economy is better placed to withstand any shocks that arise.

Going by the latest estimates of the NSO, the government is likely to fall slightly short of the nominal growth target of 10.5 per cent for FY25. It may still meet the fiscal deficit target of 4.9 per cent of gross domestic product (GDP) because capital expenditure will fall below the budgetary estimate. 

For FY26, the priority must be to maintain the central government expenditure at the FY25 level of 3.4 per cent of GDP, at the very least. This must not happen at the expense of capital expenditure by public sector undertakings (PSUs). Total central public expenditure (central government plus central PSUs) must be maintained at the FY 25 level of 4.5 per cent. 

This could well mean exceeding the fiscal deficit target of 4.5 per cent of GDP for FY26 indicated in last year’s Budget. So be it. The imperative is to aim for GDP growth of close to 6.5 per cent in the coming year. It is hard to see any big rise in private investment driving growth in the face of looming uncertainties. 

The finance minister had indicated in her speech last year that, from FY27 onwards, the government would focus on ensuring a fall in the central government debt-to -GDP ratio rather than on the fiscal deficit itself. In blunt terms, this means letting go of what has turned out to be a futile two-decade quest to meet the Fiscal Responsibility and Budget Management (FRBM) fiscal deficit target of 3 per cent. 

A strong fiscal stimulus is especially required because the scope for monetary easing may turn out to be less than what analysts had hoped for. The issue may not just be the persistence of domestic inflation. Mr Trump’s position on tariffs spells higher inflation in the US and a strengthening of the dollar, at least in the short-run. The US Federal Reserve has indicated that rate cuts in 2025 will be fewer than previously anticipated. Post-Trump, other economies may find it more difficult to delink their policy rates from those of the Fed.

The second priority in the Budget must be the issue of unemployment, especially educated unemployment. Last year’s Budget had announced three schemes aimed at incentivising employment in the private sector, along with an internship programme. It projected an expenditure of ~2 trillion over five years, or ~40,000 crore annually. However, the discernible allocation in the Budget was only ~12,000 crore.

The coming Budget should tell us what the outcomes have been. It is unlikely that the private sector has met the government’s expectations for job creation, or that it will in the future. Manufacturing has not taken off as expected, and it cannot be relied upon to generate large numbers of jobs in the near future. The services sector generates jobs but many are of low quality. 

To alleviate educated unemployment on a crash basis, the government must go all-out to fill vacancies in government. It must also offer the promised internship stipend of ~5,000 to all those who apply for internship through the government’s portal and fail to secure one within six months. 

There will be much hand-wringing over unproductive jobs in government and freebies. Critics will say that the government must instead invest more in education and healthcare or in infrastructure. The latter would create conditions for the growth rate to move to over 7 per cent. 

We have seen, however, that faster growth does not automatically create sufficient jobs or the right quality of jobs, not just in India, but also in other parts of the world. A large swathe of the population needs relief. With both the Centre and the states announcing handouts in various forms, we are moving towards an Indian version of a Universal Basic Income. Like it or not, that is the consensus across the political spectrum. If we can, nevertheless, sustain GDP growth at around 6.5 per cent in an adverse  global environment, investors will view India’s growth-with-inclusiveness model as no mean achievement. 

Lastly, the government must focus on improving governance and performance at PSUs and public sector banks. The imperative is even stronger now that privatisation   and asset monetisation have been put on the back burner.  

The Financial Services Institutions Bureau has turned out to be a good model for making top-level appointments. The Bureau comprises professionals, a representative of the RBI and a representative of the finance ministry. It recommends whole-time directors and non-executive chairpersons for financial institutions. The government takes a call on the recommendations made by the Bureau. 

The Bureau’s mandate should also be extended to the appointment of independent directors. The responsibilities cast on independent directors by the RBI have increased considerably. Compensation for independent directors at public sector banks needs to be improved-it is eminently affordable today. A graded scheme can be introduced, depending on the size and performance of a bank.

The Public Enterprise Selection Board, which performs similar functions at public enterprises in the non-financial sector, needs to be recast along the same lines as the FISB. It too must be mandated to appoint independent directors and on better terms. A separate panel could be created to evaluate the performance of boards at all public enterprises.

A growth rate target of around 6.5 per cent, a high level of public capex, increased government spending on job creation, a relaxed view of the fiscal deficit target, and a greater focus on performance at PSUs/PSBs—the recipe may seem distinctly unglamorous. Well, that is what is required in the uncertain times that the arrival of Mr Trump bodes.

Elon Musk wants regime change- in the UK!

The US is notorious for its attempts at regime change over the years. But that was almost always in the Third World or non-Western world.

Who would have thought that the US would want a regime change at one of its closest allies, the UK? And yet that is what Elon Musk has been doggedly pursuing over the past few months. Earlier, Musk spoke as a private citizen. But  no longer. He is now part of President-elect Donald Trump's incoming administration. 

Musk has publicly called for British PM Keir Starmer to step down saying he no longer enjoys public support. He has said that Starmer's continuance in office could spell civil war in the UK. He has lambasted Starmer for his alleged failure to crack down on criminal gangs in the sexual abuse of young girls when he was Crown Prosecutor.

And now comes the report that Musk is discussion with various groups in the UK to bring about Starmer's ouster well before the next UK elections. Musk has been talking to the UK's Reform Party to bring about regime change in the UK. But he dropped a bombshell recently by saying that the party leader, Nigel Farage, is not the right person to head it. This, after Farage had met him a month ago.

It is astonishing that there has been little condemnation of Musk's activities in the UK in the UK itself, on the European continent and in the US. Russia and China have been condemned for supposed acts that were nowhere as crude as what Musk is attempting.

Any self-respecting government would have warned a foreign individual off such blatant interference in its internal affairs. But when it comes to the US and Mr Trump, the norms are clearly different. How the British have fallen!

Manmohan Singh as talent spotter

Among the many tributes that have been paid to Dr Manmohan Singh, this one focuses on his ability to spot and nurture talent.

Among the many bright people Singh brought into or promoted in government were: C Rangarajan, Y V Reddy, MS Ahluwallia, Rakesh Mohan, Shankar Acharya, Jairam Ramesh, Nitin Desai, Arvind Virmani, Bimal Jalan, Vijay Joshi, Raghuram Rajan and Urjit Patel. Building leaders for the future is one of the principal task of a leader. It can be said that Dr Singh performed this role in an exemplary manner.

There is also a rousing tribute from Martin Wolf in the FT:

Singh achieved what he did because he was a special man at a special time. Ultimately, however, technocrats only succeed if those with power trust them with it. India benefited from the fact that people with power were willing to trust him to use it well at critical moments. He, in turn, provided something that today’s populists increasingly despise: knowledge, wisdom and experience. He also knew the importance of brilliant colleagues. A recent paper from the Mercatus Center describes him as “India’s finest talent scout”. In some quarters today, all this would condemn him as an embodiment of the “deep state”. That is because these people lack belief in the ideal of public service. Singh did believe in it. He believed, too, in a thriving democracy. Indeed, he thought India could not survive without one. The economically dynamic India of today is his legacy. So, too, is his example of service to the cause of a prosperous India in harmony with the world.

Why is media talking about Trump firing the Fed chief?

One is intrigued by the incessant speculation in the media about Trump's firing Fed Chairman Jay Powell once Trump is sworn in as president later this month. Kenneth Rogoff resurrects this speculation in a recent article but is quick to shoot down the possibility. 

By law, the Fed Chairperson has a fixed tenure. The President does not have the legal right to fire him or her. Of course, the President can get Congress to amend the law so as to enable to the President to fire a Fed Chief. But pushing through such legislation will not be easy despite the fact that Mr Trump is riding high at the moment. Opposition from Congressmen apart, Mr Trump has to risk with the damage such a move could inflict on the financial markets. Mr Powell, for his part, has said he has no intention of resigning.

Mr Trump can, of course, seek to undermine Mr Powell by criticising his moves. But he did so in his first term without inflicting any serious damage to the functioining of the Fed. Central bank independence does not mean the political authority cannot air its differences with the central bank in public. 

There is the larger question of whether the central bank chief must serve at the pleasure of the government. That is the case in India. It is open to the government to ask the RBI Governor to go- and without assigning reasons. That does not mean that is easy for any government to do so- as I mentioned earlier, the credibility of the central bank and the damage to financial markets and the economy are considerations that no government can brush aside. It's not easy to ask an RBI Governor to go even if the government has the authority to do so.

That apart, the RBI is not in the same position as the Fed. The Fed focuses on monetary policy and has some responsibility for bank regulation. The RBI is a full-scope central bank encompassing monetary policy, bank regulation, exchange rate management, government borrowings, currency management etc. Independence of the central bank is about independence in monetary policy. Such independence cannot extend to the other areas for which RBI has responsibility.

Lastly, chemistry at the top is important. The head of government must have a certain degree of comfort with the central bank chief . Where that comfort level is not there, the government should have the right to replace the central bank chief. That is not to say that the central bank chief must be a stooge of the government- no intelligent head of government would even want that because ultimately politicians in a democracy do feel the need to deliver. And they would understand that having an independent central bank is crucial to that objective. 

Mass deportations are not new to America

Trump's threat to throw out illegal immigrants in large numbers has raised hackles in several quarters. He is portrayed by some as a heartless monster who will show no mercy to illegal immigrants.

Hang on! Mass deportations are not new to the US at all. During President Biden's time, the US is said to have deported over 140,000 persons in fiscal 2023 alone. The Economist reported recently that the peak in Obama's time was 400,000. And the all time high was in during Eishenhower's tenure- one million! 

Wonder which of these numbers Trump will be able to beat. 

Trump and tariffs: have no illusions

If death and taxes are the two certainties of life, there is a third when Trump is around: tariffs. Trump is committed to using tariffs to further American economic interests. He may be willing to be flexible on the level of tariffs after discussions with America's trading partners but nobody should have any illusions about his not using them.

I was convinced on this issue after reading Robert Lighthizer's book, No Free Trade. Lighthizer was the US Trade Representative on Trump's earlier presidency and was a contended for the Treasury Secretary's job this time around.

The central theme of the book is that tariffs are necessary for America, will work for America and they are part of Trump's vision of how America needs to be remade.

My article in BS on this subject is reproduced below:

Never in recent memory has the fate of the world at the approach of a New Year hinged on one person as it does today. In recent weeks, it has seemed that key political and economic decisions in the world’s political capitals are on hold until Donald Trump’s assumption of office as President of the United States next January.  

The US is, by a wide margin, the world’s pre-eminent power. The actions of its President are bound to impact the rest of the world. However, Mr Trump is not just another US President. In respect of both foreign policy and economic policy, he represents a sharp discontinuity, one that is  potentially  disruptive for the US as well as the rest of the world. That is why the world watches with bated breath. 

In the realm of geopolitics, the world awaits Mr Trump’s moves in respect of two hot spots, West Asia and Ukraine.  Economic policy makers are bracing for Mr Trump’s moves  on two of   his key promises: Higher tariffs on imports into the US and a crackdown on illegal immigration. 

The demonisation of Mr Trump is so common   in the Western mainstream media that he isn’t being given credit for swearing by something that few would disagree with: The world could do with fewer wars. It is worth quoting from a speech Mr Trump made in March 2023:

“We need PEACE without delay. In addition, there must also be a complete commitment to dismantling the entire globalist neo-con establishment that is perpetually dragging us into endless wars, pretending to fight for freedom and democracy abroad, while they turn us into a third-world country and a third-world dictatorship right here at home. The State Department, the defence bureaucracy, the intelligence services, and all the rest need to be completely overhauled and reconstituted to fire the Deep Staters and put America First.”

If that is not radical thinking, one knows not what is. The big question is whether the Deep State will let Mr Trump get on with the agenda he has in mind.  

In West Asia, Mr Trump has been presented with a fait accompli of sorts with the overthrow of the Assad regime in Syria.  The issue is not whether Mr Trump can extricate the US from Syria.  It is how he intends to deal with plans for the creation of a Greater Israel and the neo-con project to deal with other hostile regimes, notably Iran. There is the power of the Israel lobby in the US. Mr Trump himself has been hawkish on Iran. For Mr Trump to put his vision of peace into practice where West Asia is concerned will be quite a challenge.

On Ukraine, there is scope for greater optimism. Mr Trump has been emphatic that Ukraine must negotiate an end to the conflict with Russia. The Biden administration attempted to queer the pitch for Mr Trump there too by allowing Ukraine to fire long-range missiles into Russian territory. Russia responded with a new missile to which NATO apparently has no counter-measure. After a two week break, Ukraine has again fired long-range missiles into Russia. A strong retaliation from Russia is on the cards  

Russia has made it clear that it is not willing to freeze the status quo and that any settlement will now have to be pretty much on Russia’s terms. We should not be surprised if Mr Trump   decides to end America’s involvement in Ukraine by forcing President Volodymyr Zelensky’s hand.

On the US home front, there is no ambiguity whatsoever. An increase in tariffs and the deportation of illegal immigrants are both certainties. The only question is how far and how quickly Mr Trump will go in implementing these measures.

Tariffs are an article of faith with Mr Trump. He deeply and genuinely believes that tariffs are needed to realise his vision of a prosperous United States. His commitment to tariffs dates back to the late 1980s- in 1989, he had called for tariffs of 15 to 20 per cent on Japanese imports to curb the trade deficit.

Those in doubt may want to read Robert Lighthizer’s No Trade is Free. Mr Lighthizer was US Trade Representative in the previous Trump administration and had Mr Trump’s enthusiastic backing for his ideas. He was a contender for the post of Treasury Secretary or Commerce Secretary this time around but didn’t make the cut.  It would be a mistake to think that the case against free trade arises from ignorance of basic economic precepts. It is a carefully thought through position. Mr Lighthizer’s main points are as follows. 

First, the efficiency argument for free trade is flawed because the benefits accrue to a few, while the losers are more numerous. And no, the losers aren’t compensated through the gains from trade. For example, manufacturing workers cannot be easily retrained to do skilled work in services. The relocation of whole communities is not a simple matter either. Secondly, the services sector does not create jobs on the same scale as manufacturing. Only manufacturing can provide well-paying jobs for the vast majority of Americans. 

Thirdly, the US needs manufacturing because it is not in the interest of national security to be dependent fully on others for goods such as steel and pharmaceuticals. Manufacturing exports are nine times bigger than services exports and hence are vital to containing the US trade deficit. Manufacturing is a big source of innovation and has driven innovation in services, so it is not that services can be delinked from manufacturing. 

Fourthly, it is incorrect to suppose that the US trade deficit is self-correcting through a fall in the value of the dollar. The US has been running trade deficits for decades – and these keep growing. The US is the world’s reserve currency, so the dollar attracts capital inflows, which comes in the way of dollar depreciation. America’s leading trade partners, notably China, tend to manipulate their currencies to keep their exchange rates low. They also indulge in “unfair trade”- subsidising domestic companies and erecting non-tariff barriers. 

Mr Lighthizher’s punchline: All the great economies of the world were built behind a wall of protection and often with government money. The NDA government’s initiatives to boost segments of manufacturing through a combination of subsidies and tariffs are in line with Mr Lighthizer’s thinking and that of Mr Trump. 

Economists may ridicule Mr Trump’s belief in tariffs as an instrument for remaking the US. However, as his convincing win in the recent presidential elections shows, his anti-globalisation stance captures the mood of the majority of the American electorate. In the New Year, the world has little choice but  to adjust to Mr Trump’s way of thinking.  

Musk's comments: will the UK have the spine to respond?

Elon Musk has launched another salvo at the UK: he has asked for fresh elections, citing a poll that showed that Keir Starmer's Labour party had lost support amongst the people. Earlier, Musk had said that the UK was headed for a "civil war". 

The UK is not the sole ally that Musk has targeted. Musk has trained his guns on Justin Trudeau of Canada calling him an "insufferable fool" and predicting the collapse of his government. In Germany, he has thrown his weight behind a far-right party.

Just imagine. Had Russia made such remarks, how would Western governments respond? Musk is no longer just a private citizen. He is seen as Donald Trump's right-hand man and has been named to the new administration. His remarks cannot be lightly dismissed. They amount to blatant interference in British politics. Will the UK have the spine to respond?

It's hard to see how the Starmer dispensation can get its equation with Trump right even if were to ignore Musk's remarks. The Labour party had infuriated Trump by sending several of its senior figures to Kamala Harris' presidential convention in Chicago last July. The UK Foreign Secretary, David Lammy, will find it difficult to live down his characterisations of Trump in the past- "neo-Nazi", "tyrant", "xenophobic". Lammy has dismissed those remarks as those of a back-bencher but then Mr Trump may be in no mood to forget and forgive. 

Workplace culture: Regulation is unavoidable

Like so many others, I was shocked by the demise of Anna Sebastian, a young chartered accountant who worked for a Big Four accounting firm, repotedly because she could not cope with the pressures at work. I wrote up an article and sent it in to the Hindu late September. They carried it a few days ago. I reproduce it below:

We need to address India’s workplace culture

 

If we are to address the worst excesses of India’s corporate culture, some form of regulation seems unavoidable

 

T.T. Ram Mohan

 

In September, the mother of Anna Sebastian, the young chartered accountant who passed away in July allegedly due to work stress, said, “They say we have received freedom in 1947, but our children are still working like slaves.” Her anguished cry goes to the heart of the issue of workplace culture in India’s corporate world.

The inquiry report of the Ministry of Labour, promised within 10 days, is still awaited. The corporate world has chosen to remain largely silent on the tragedy. What corporate leader would dare to point fingers at others when the position at his own firm is not very different?  

Toxic work culture

The issue is not just long hours or having to put in extra effort to meet a deadline. Employees will gladly slog it out if they are shown respect, appreciated, and feel they are treated fairly.   From all accounts, much of corporate India fails on every count. Toxic work culture is pervasive in India’s private sector.

 

Long hours flow directly from a focus on the bottom line that comes at the expense of employees’ well-being. The management employs two people where four are required. It seeks to motivate the two employees by giving them the wages of three, thus saving on one employee. Impressive jargon hasbeen created to justify exploitation of employees and inhuman work hours. Meeting stiff targets against heavy odds is ‘organisational stretch’. There is ‘variable pay’ to promote a ‘performance culture’ that translates into a higher stock price — great for top management that corners most of the stock options. There is a ‘bell curve’ that identifies super-performers as well as under-performers. There are ‘stress management’ workshops to deal with the burn-out that ensues.  Management does not stop to ask itself why it is creating so much stress in the first place.

 

Long hours and employee burnout are typical of the corporate culture of the U.S. but not of Europe. France has a 35-hour work week. In the rest of Europe, the norm is about 40 hours. European firms lack competitiveness, did you say? Well, European standards of living are nothing to scoff at.

 

It is unrealistic to try to import the American culture into a setting that could not be more different. The per capita income in the U.S. is $85,000. In India, it is $2,700. The typical U.S. employee operates at a level of comfort — in terms of housing, commuting, health, diet, and leisure — that is way above that of the Indian employee. In India’s big cities, simply going to office and getting back can be an ordeal. So are getting school admissions for children (and then getting them into coaching classes), looking after an elderly parent, and generally ensuring that the household is ticking along.

 

Long hours are only part of the problem. Bosses often use language that can range from being unprofessional to abusive. During the tenure of Prime Minister Rishi Sunak, his deputy, Dominic Raab, faced charges of ‘bullying’ from officials he had worked with in his previous stints as minister. An enquiry found that he had been “aggressive” and “intimidating” but not “abusive”. Mr. Raab, nevertheless, had to resign. Such was the fate of the U.K. Deputy Prime Minister, no less, for having breached norms of civilised behaviour.

 

One wonders what would happen if these standards were applied to India’s corporate world. In the U.S. and in Europe, employees can sue the firm for a range of objectionable behaviours including those that cause them mental stress. They often win huge settlements. No such recourse is available in India.

 

Employees also feel they are not treated fairly. The performance evaluation system is often suspect and the ruthlessness with which so-called under-performance is dealt with will make one squirm.  Top management will talk of “weeding out dead wood”, an expression that shows  scant regard for the worth of human beings. Variable pay is heavily skewed in favour of a handful of individuals at the top. When those below seethe with resentment at what they perceive as unfair, a toxic culture is inevitable.

 

Many public sector firms have a much better work culture. Employees may not get huge rewards but they have job security. Unions act as a check on the arbitrary ways of top management. Inequality in pay is nowhere as glaring as in the private sector. Officers at the middle and senior levels put in long hours. People have their grievances. But complaints about a toxic work culture are rarer.

 

Time to remedy matters

How do we remedy matters? Corporates can be expected to be respond along predictable lines: there will be affirmations of “core values”, a new “code of conduct” for management, programmes to address the “work-life balance”, more “town hall meetings” with employees. If these could make a difference, we shouldn’t be having a problem in the first instance. The board of directors should be paying attention to the company’s work culture, providing recourse and initiating corrective measures. Alas, boards  tend to be even more disconnected from reality than the management. Moreover, they lack the incentives or the motivation to challenge   management.

 

If we are to address the worst excesses of India’s corporate culture, some form of regulation seems unavoidable. Regulation may get boards to assume responsibility for the work culture, engage with employees at lower levels, and get a sense of what’s going on.  The Nirbhaya episode caused a paradigm shift on the issue of women’s safety. One hopes that Sebastian’s untimely demise will likewise turn out to be a defining moment for India’s workplace culture.

 

 

Central banks have won the battle against inflation

 

As inflation soared to levels unknown in decades in two years ago, central banks came in for severe criticism for not reining in demand earlier.  Bring inflation down to target would mean a huge sacrifice of growth, critics said.

They have been proved wrong. Inflation has been brought down over the past two years with a modest sacrifice of growth. One has lost count of the number of analysts who said last year that the US economy was sure to slip into recession, if that had not already happened.

Central banks have improved their tool-kit over time. However, as I argue in my recent article in BS, Central banks have the last laugh,  their success in the recent bout of inflation owes to several factors beyond their control.

Central banks have the last laugh

The world economy will grow at 3.2 per cent in 2024 and 2025, says the International Monetary Fund’s (IMF’s) latest Economic Outlook. That is below the 3.6 per cent growth rate seen during 2006-15. Yet, the relief over the growth projections is almost palpable. 

There is relief because  the battle against record levels of global inflation has been won- or so the IMF declares- without as much loss of growth as was feared. Inflation rates are trending down without the global economy going into recession. Commentators who had been critical of central banks’ responses to post-Covid inflation have been proved wrong.  

Global inflation peaked at 9.4 per cent year-over-year in the third quarter of 2022. In the US, the inflation rate rose to 9.1 per cent in June 2022. Since then, inflation rates have been dropping. Global headline inflation rates is now projected to reach 3.5 per cent by the end of 2025,   below the average level of 3.6 per cent between 2000 and 2019. 

As inflation started surging after the Covid-19 pandemic, central banks were roundly criticised for tightening too little and too late. Since central banks were slow to react, critics said, monetary tightening would have to be extremely aggressive. A soft landing was almost impossible.  

Central banks have also been faulted for being slow to loosen monetary policy when the inflation rate began to decline, and growth was seen to be faltering. Might they have done anything differently? Since the actions of central banks were broadly synchronised, let us focus on the actions of the US Federal Reserve.

The pandemic was correctly seen as giving rise to a supply shock as well as a demand shock.  Monetary (and fiscal) policies to boost demand were entirely appropriate.   Expansionary policy caused the inflation rate in the US to rise above the target rate of 2 per cent in March 2021. 

Once the pandemic-induced restrictions were progressively removed through the second half of 2021, producers found it difficult to ramp up output due to supply chain disruptions. Demand ran ahead of supply, the US inflation rate surged.  There was an expectation that as supply bottlenecks eased, inflation would come under control. In any case, the Fed could not have been expected to tighten policy when the pandemic was still raging.

By December 2021, the inflation rate in the US had touched 7 per cent.  Just as central banks were preparing to tighten policy in early 2022, there came another shock-- the onset of conflict in Ukraine in February that year. Oil prices rose sharply amid expectations that the oil market would be severely disrupted. Inflation in the US shot up to 7.9 per cent in February. By mid-2022, global inflation had tripled relative to its pre-pandemic level. 

The Fed commenced tightening from mid-March 2022, with a 25 basis points (bps) increase in the policy rate. By June 2022, the policy rate in the US had jumped by 150 bps. By July 2023, the rate had gone up by more than five percentage points. Should the Fed and other central banks have tightened even more and even earlier in response to the Ukraine conflict? 

The short answer is that central banks’ responses to such events can only be tentative.  Could anybody have imagined that the conflict in Ukraine would go on for over two years? And that, two years into the conflict, oil prices would be contained at below $80 a barrel, thanks in part to the EU/NATO-imposed price cap on oil imports from Russia?  How much to tighten monetary policy and at what pace in response to such events can only remain in the realm of guesswork.

Suppose the Fed had indeed tightened earlier. What might have happened? The IMF’s Outlook uses a model to examine the outcomes had the Fed tightened three quarters earlier than observed. It finds that peak inflation would have been 2 percentage points lower than what was observed. However, real gross domestic product (GDP) would have been 0.2 percentage points lower. The model suggests that the Fed got the timing right.

 Inflation in the US stayed above 5 per cent until March 2023. Even last September, it was above the target rate of 2 per cent. The conventional wisdom is that when inflation stays high for so long, it is very difficult to get the inflation rate to fall without a substantial sacrifice of growth. Yet the sacrifice of growth has been minimal. 

There are several explanations for this seeming miracle. 

First, as the IMF points out, inflation expectations stayed “anchored”, that is, people did not change their long-term expectations. One can only speculate as to why this happened. It may well be that the credibility of central banks has gone up in recent years.  Economic agents may have seen the pandemic and the deviations from the inflation target that happened as a black swan event.    They may have believed that central banks had the competence to bring inflation to heel sooner rather than later.

Secondly, the Phillips curve appears to have steepened during the high inflation period. This implies that any monetary tightening and the economic slack it creates would result in a greater reduction in inflation than when the Phillips curve is flatter. Central banks end up producing better results than in normal times.   But then how on earth are central banks to anticipate the steepening of the Phillips curve in such times?

Thirdly, high inflation rates did not trigger a wage-price spiral that would have rendered the inflation rate stubborn. One reason certainly is that the power of trade unions in the advanced economies has declined  and workers have less bargaining power. 

Fourthly, the increase in commodity prices was less than, say, during the oil shock of the 1970s, and the energy-intensity of economies itself has declined. Inflation caused by commodity shocks is intrinsically less of a problem today, and a lighter hand is needed to deal with it. It is fair to say central banks have been helped by a combination of favourable factors.

One issue remains. Should central banks have started cutting rates even earlier? Well, with the geopolitical risks that we face, central banks have to tread warily. The conflicts in Ukraine and West Asia have escalated. Either could have spun out of control –and still can. The American presidential elections have posed their own uncertainties. No central bank wants to loosen policy only to tighten soon thereafter.

 Getting policy right in the face of so many imponderables will always be a challenge. In the present round, central banks have had the last laugh. Whether their success is due to tactical genius or pure serendipity is anybody’s guess. 

 

Lebanon and Iran: the fog of war and some unusual voices on the conflict

Does anybody know what exactly is the military situation in Lebanon? It is impossible to tell because there is very little coverage in the mainstream media and what we have is mostly the Israeli point of view as told by embedded journalists.

Israel's ground invasion of Lebanon has been on for more than four weeks now. Reports of the progress made by Israel vary widely. Israel wants to push the Lebanese militia, Hezbollah, beyond the Litani river. It would like to clear an area of about five kilometres into Lebanon from the border of bunkers, tunnels and Hezbollah fighters so that Hezbollah cannot fire artillery rounds into Northern Israel. (It would still be able to fire rockets). 

How far have these objectives been achieved? The Institute for the Study of War, a US based think-tank, contends that Israel has had considerable success. Other military analysts dispute this claim. They say the IDF is heavily bogged down,it has not penetrated more than three kms into Lebanon and it withdraws after making incursions. In other words, the IDF is loath to stay deep inside Lebanese territory for fear of inviting fierce reprisals from Hezbollah. The IDF top brass says it has substantially achieved its objectives in Lebanon and the time is ripe for a political settlement. That is not quite the same as what PM Netanyahu wants to achieve, which is to change the strategic situation in Lebanon drastically, with the elimination of any political role for Hezbollah.

Now, let's turn to Iran. About a week ago, the long promised Israeli attack on Iran materialised. The Israeli version is summarised by the Economist:

How effective were the Israeli strikes? So far there is too little evidence to be sure. Israeli officers claim they destroyed most of Iran’s advanced air-defence capabilities and that, as a result, their air-force can operate freely in Iranian airspace. If true, it means a future Israeli strike could be much more extensive.

According to Israeli security sources, most of the targets this time were hit by air-launched ballistic missiles (ALBM) fired from aircraft well out of the range of Iran’s defences. Israel’s stock of ALBMs is limited and a more intensive air-strike campaign against Iran would call for a large number of jets using munitions at a shorter range. If Israel’s claims about this strike are true, this is now possible. It will take many months for Iran to rebuild its air-defences, especially when its Russian suppliers need their own batteries for their war with Ukraine.

Other reports say that important sites that produced material for ballistic missiles were hit. Iran's ability to produce long-range ballistic missiles is thus seriously impaired and Iran's military capability compromised. It will not be in a position to mount any more attacks on Israel in the near future. 

However, several media reports suggets that a strong Iranian response is pretty much on the cards. One military analysts, Alastair Crooke, says that the IDF had planned several waves of attacks but it had to stop after the first wave because Iran displayed an air-defence mechanism that the IDF was not aware of.  If these stories are correct, the Economist version becomes suspect. 

It is impossible to go by what appears in the mainstream media. The media merely cite Israeli and Western sources but have no means of independently verifying what is told to them. I have been reading and listening to several independent military analysts. I do not know how right they are but what they say is certainly interesting. Let me list a few prominent ones:

i. Elijah Magnier: He's a veteran war correspondent who tweets regularly on X. His tweets are free. He has more detailed analyses. A basic part is free but the rest is available only through subscription. I have access to the full versions. Magnier is emphatic that the ground invasion has turned out to be unsatisfactory, if not disastrous, for IDF and that Israel will sue for peace before long.

ii. Colonel Douglas Macgregor: A former US army officer who has also served in the Defense department. Macgregor is among the analysts who predicted long back that Ukraine and Nato would face defeat in the fight with Russia. He has been proved right although the conflict has stretched out much longer than he had forecast. Macgregor does not see the conflict in Lebanon going well for Israel.

iii. Scott Ritter: He's a former US marine and weapons inspector in Iraq. He has had the same views on Ukraine and the Middle East conflict as Macgregor.

iv. Alastair Crooke: He's a former UK diplomat who served extensively in the Middle East and developed contacts with Palestinian groups, Hezbollah and officials in the government of Israel. Only recently, I have been hearing that he was, in fact, an MI6 agent- I don't know if that is true. Crooke sees Israel's plans unravelling swiftly. He has also forecast certain doom for Ukraine.

iv. Andreas Krieg: He's a faculty member at King's College, London. He too tweets on X and provides extensive background to the Middle East conflict and views on the unfolding situation.

v. Rania Khalek: She's an American journalist of Lebanese origin. She gives expression to the outrage amongst people of Middle East origin in the US over the destruction of Gaza and Lebanon.

vi. War Monitor: This is again on X. I don't know who the author is. But this is a source that provides frequent updates on the war front in Gaza as well as Lebanon.

For the official Israeli and Western version, there is the website of the Institure for the Study of War.

One thing is for sure. The social media has become an indispendable to getting a complete picture of events. The mainstream media can at best give only  a partial account and often a distorted account.