Global economic trends have a significant ripple effect around the world, particularly impacting emerging markets. A key driver of these trends is the interest rate policies set by major central banks such as the U.S. Federal Reserve and the European Central Bank. A recent simulation by the Asian Development Bank (ADB) has indicated that a scenario where these institutions maintain ‘higher for longer’ interest rates, deferring cuts beyond 2024, could have significant adverse effects. These effects extend to the growth and inflation outcomes of emerging economies, with India poised to experience some of the most substantial impacts within the Asian region under such circumstances.
The simulation projections underscore that India could witness an escalation in inflation by approximately 0.4 percentage points throughout 2024 and 2025. Additionally, the nation’s GDP growth may witness a slight reduction, just under 0.2 percentage points, in 2025 when contrasted with ADB’s baseline forecasts. Notably, the ADB has envisaged growth at 7% for the current year, prior to a rebound to 7.2% in the 2025-26 period. Furthermore, it has projected an average inflation rate of 4.6% in 2024-25, which is expected to be followed by 4.5% in the succeeding fiscal year.
Abdul Abiad, the director of ADB’s macroeconomics research division, highlighted the pertinence of these projections in light of recent U.S. inflation data. “We simulated the potential impacts of a ‘higher for longer’ interest rates scenario… [and] this is particularly relevant since the U.S. inflation figure came in at 3.5% for March, which is above expectations and higher than the 3.2% inflation recorded in February,” he elucidated.
The primary effects on emerging economies are manifested through interest rate differentials, inducing an initial devaluation in their currencies. A relative increase in the value of the U.S. Dollar and Euro, in this persistent high-rate environment, could usher in higher inflation for imported goods due to the diminished strength of regional currencies.
Consequently, this scenario is projected to add approximately 0.15 percentage points to inflation in high-income technology exporters and other developing Asian economies compared to the baseline in 2024 and 2025. While the inflationary and growth impact on developing Asia is marginal, India’s situation is described as more acute and lingering. The pronounced sensitivity of India’s inflation to exchange rate fluctuations and its considerable dependence on imports underscore the intensified impact anticipated for the country, according to ADB’s findings.
On a more positive note, currency depreciation will offer some benefits to India by boosting export competitiveness. This change could contribute 0.05 percentage points to GDP growth this year. Nonetheless, this beneficial effect on growth may reverse in 2025 and 2026 as the monetary policies ease in the U.S. and Eurozone, potentially nullifying the earlier advancements in exchange rates.
Abiad also brought attention to specific risks emanating from ongoing conflicts in the Middle East and disruptions in crucial shipping routes due to tensions in the Red Sea. As commercial ships are compelled to traverse longer and more expensive paths, the persistence of exorbitant shipping costs—which surged by 82% between September and December 2023 and witnessed fresh spikes since February—could magnify inflationary pressures.
“The inflationary impact [in developing Asia] is persistent, peaking 13 months after the initial shock in October 2023. At that point, it is estimated to add about 0.4 percentage points to inflation, and then subsides gradually, should there be no further shocks,” the economist stated.
While these predictions set a cautionary narrative for the Indian economy and other emergent markets in Asia, they also outline the interconnectedness of global economic policies and their far-reaching consequences. It remains to be seen how central banks across the world, and in India specifically, will navigate these challenging macroeconomic waters in the coming years.
