Rarely has the coming year been so uncertain. I am a qualified optimist. I think the chances of a happy ending are higher than chances of continuing attrition or a sad ending. But this assumes that political leaders will ultimately be rational, something that can never be taken for granted.
India will not be able to choose its policy stance in 2023; it will have to react to a very volatile global situation. In a best-case scenario, growth could zoom to 7%. In a worst-case scenario, it could sink to half that. The finance minister needs to prepare for 5.3% growth – a widely predicted rate because of global recession – while planning for fiscal and monetary flexibility up and down. Investors would do well to adopt a conservative stance and watch how the winds change.
The Ukraine war will dominate politics and economics. Russia is preparing a new offensive on Kyiv, and this time it will not be pushed back as easily as it was last year. Ukraine regained some territory, including Kherson city, last autumn. But for Ukraine to militarily defeat Russia seems a stretch, especially since NATO has decreed that its munitions must not be used for operations across the Russian border, in order to avoid escalation.
A stalemate is probable right through 2023, with both sides becoming cautious as they run short of ammunition. Behind-the-scenes talks have already begun on a face-saving formula to end hostilities. I doubt if these will bear early fruit. Things may have to get worse before they get better.
The economic outlook is clouded, and even a ceasefire in Ukraine may not save the world from a serious recession, though nothing remotely as bad as in 2008.
Inflation may Persist
Europe is already mired in recession. Gas shortages and high prices will mean a cold, hard winter. The price cap on imports of Russian energy will probably fail – markets have methods of finding their way round most sanctions. Yet the short-run impact may well be a rise in prices as sanctions create supply shortages.
Optimists think the worst is over in inflation and prices will drift down in 2023, enabling central banks to cut interest rates. But 2022 has shown that inflation can be far more persistent than any central bank has anticipated. Recession may well send metal prices down but energy and food prices could remain high because of supply disruptions arising from sanctions and price caps. Core inflation is turning out to be stubbornly high in the US and Europe, with services inflation refusing to fall. So, lower commodity prices may not automatically cure inflation.
The US labour market is still so strong – and unemployment remains so low – that many analysts feel it may escape a recession in 2023 or suffer the mildest of downturns. However, if unemployment fails to rise above 5%, purchasing power will remain too strong to tame inflation. The Fed may find that it has to persist with higher interest rates much longer than it anticipates. It may prove impossible to tame US inflation without inducing a serious recession.
What about the worst-case scenario? If Russia is unable to make military progress and gets hobbled by sanctions, it may in desperation use tactical nuclear weapons. These are low-yield nukes that cannot wipe out a city but can wipe out a tank formation. This could escalate into an all-out nuclear war, though high-power conventional bombardment is a more likely form of western retaliation.
Whatever the final outcome in such a disaster scenario, economic growth will plummet and stock markets will collapse. I am a qualified optimist, I repeat, and expect disaster to be avoided. But the risk cannot be dismissed lightly.