Newspaper Summary - 080626

 

The conservation kitty just shrank 36%

EARTH SHIELD. As governments falter, the recent Global Environment Facility meet in Samarkand rested its hope on private funding

By Joydeep Gupta

The Global Environment Facility (GEF) will have at least $3.9 billion till 2030 to spend on projects to conserve biodiversity in countries and across borders, combat climate change, and deal with desertification, mercury poisoning and persistent organic pollutants. This is almost 36 per cent less than the $5.3 billion that the GEF had for the four years ending in 2026 — a reflection of the reduced financing from developed countries to safeguard the earth. The US has not paid for the coming four years, while India is paying $20 million, the same as it did four years ago.

On the eve of the GEF assembly, held once every four years, its council approved a $13.49 million grant to help conserve biodiversity in three states of India — Uttarakhand, Nagaland and Tripura. The World Bank is lending $30 million for the project. During the meet in Samarkand, Uzbekistan, from May 30 to June 6, the GEF approved 24 projects in 22 countries and promised to spend $232.5 million for them. GEF interim CEO Claude Gascon acknowledged that the money available was nowhere near enough, stating the world "can’t afford fragmented responses to integrated crises".

Private Funding Needs Because government funding is falling short, there was near universal acceptance at the summit of the need to leverage private sector funding. Gascon discussed the goal of every dollar paid by GEF leveraging 18 dollars from the private sector, using examples like rhino and lemur species bonds recently launched in Africa. Other officials spoke of moving beyond the "comfort zone" of co-financing from the World Bank to using GEF grants as guarantors for commercial bank loans.

Less Money, More Red Tape Developing country representatives raised concerns about funding approvals taking too long and processes being too complicated. In response, a package was adopted to make the GEF faster and more accountable. Of the 2026-30 funds, 35 per cent is earmarked for least developed countries and small island developing states. Additionally, 20 per cent of funds ($100 million) has been dedicated to indigenous peoples and local communities to bypass government red tape.

New Project in India (CONSERVE) The new India-based project, called CONSERVE, will focus on community-managed forests, wetlands, and high-altitude meadows in Uttarakhand, Nagaland, and Tripura. Run by the National Biodiversity Authority, it aims to ultimately raise $75.6 million and engage over 25,000 people, at least half of them women. Communities will co-author governance rules, and revenue-sharing agreements will channel financial flows directly back to community institutions. The project also aims to build a management information system (MIS) to create a national biodiversity map for use in planning development projects.

Indian toy start-ups attract global investors as exports, manufacturing capacity and international demand grow rapidly

The serious business of playthings: From fun and sporty to educational, toys produced by Indian startups are increasingly in demand globally

By Sanjana B

The Digital-Tactile Shift Toys are increasingly competing for attention with electronic screens, leading Bengaluru-based start-up PlayShifu to focus on transforming passive screen time into active learning for cognitive development. Co-founder Dinesh Advani explains that their proprietary, patented technology combines physical, tactile play with digital interactivity. While online channels represent 45 per cent of their sales, nearly 80 per cent of PlayShifu’s revenue comes from international markets, with products exported to over 35 countries.

Global Sourcing Trends As global brands diversify their sourcing away from China, the Indian toy industry has become a major beneficiary. Major international names like Hasbro, Mattel, Spin Master, and IKEA are now on the client lists of Indian manufacturers. Mihir Joshi, Managing Director of GVFL, notes that stronger domestic manufacturing capabilities offer a meaningful opportunity for Indian companies to expand both locally and globally as trusted partners.

Investment Magnet The sector has become a significant draw for investors. Bala Srinivasa, Managing Director of Arkam Ventures, points out that India currently exports only $150–200 million worth of toys to a global market exceeding $130 billion, suggesting massive room for expansion. According to Tracxn, the toy industry attracted $92.6 million in funding between 2019 and 2026, peaking in 2024 with $32.9 million across 14 rounds. So far in the current year, $11.6 million has been invested.

Scaling Domestic Demand and Manufacturing

• Legend of Toys: This D2C toymaker manufactures miniature remote control cars, drones, and action figures. Its 16,500 sq ft factory in Bengaluru produces over 45,000 remote control cars per month. Co-founder Afshaan Siddiqui reports that the company grew its annual recurring revenue (ARR) to ₹30 crore in just 18 months and is targeting an exit ARR of over ₹80 crore. The company is also beginning exports to the US this month.
• Bidso India: Founded in 2022, this firm manufactures outdoor and ride-on toys under a franchise-owned, company-operated (FOCO) structure. It holds licenses for globally recognized characters including Peppa Pig, Harry Potter, Transformers, and NASA. Bidso reported ₹60 crore in revenue for FY26 and plans to expand its manufacturing footprint to 5.5 lakh sq ft by FY28.

Policy Support and Challenges Startup founders credit government initiatives for boosting the sector, specifically citing ‘Make in India’ incentives, mandatory BIS quality control clearance, and the hike in basic customs duty on imported toys from 20 per cent to 70 per cent. While rationalized duties on electronic components have helped, local supply remains a bottleneck. Additionally, the industry remains vulnerable to fluctuating plastic and metal prices and global trade disruptions. Despite these hurdles, toy exports surged over 200 per cent between FY15 and FY23, turning India into a net exporter.

Professional forecasters see FY27 GDP growth at 6.5%

WEAK OUTLOOK. It is slightly lower than RBI’s estimate; inflation projected at 4.9%

Our Bureau, Mumbai

India’s economic growth is expected to moderate to 6.5 per cent in 2026-27, while headline retail inflation is projected at 4.9 per cent, according to the Reserve Bank of India’s (RBI) latest Survey of Professional Forecasters (SPF). These estimates reflect a slightly weaker growth outlook but a more benign inflation trajectory than the RBI’s own official forecasts of 6.6 per cent GDP growth and 5.1 per cent inflation for FY27.

Rate Hike Indication

The SPF suggests limited scope for further monetary easing, indicating that interest rates will likely rise from here. Forecasters expect the repo rate to end FY27 at 5.75 per cent, which implies two 25-basis-point hikes from the current 5.25 per cent—specifically a hike to 5.50 per cent in Q3 and another to 5.75 per cent in Q4.

Future Projections and Divergences

For FY28, the panel projected a recovery in GDP growth to 6.9 per cent and inflation easing to 4.5 per cent. The 100th round of this bi-monthly survey, conducted in May with 40 panellists, assigned the highest probability for GDP growth to the 6.5–6.9 per cent range for both FY27 and FY28.

Addressing the difference between SPF and RBI estimates, Manoranjan Sharma, Chief Economist at Infomerics Ratings, noted that such differences are matters of perception, often stemming from variations in methodologies and samples. He highlighted the West Asia situation as the "elephant in the room," stating that calculations could come under strain if the conflict persists for six to eight months.

Crude Prices and Inflation Assumptions

Garima Kapoor of Elara Securities noted that both RBI and SPF forecasts are directionally similar, with gaps reflecting different assumptions regarding the war, the rupee, and oil prices. Sachchidanand Shukla of Larsen & Toubro added that divergences often arise from private forecasters taking "aggressive assumptions" on factors like El Niño.

In a June 5 statement, RBI Governor Sanjay Malhotra maintained that underlying inflation pressures remain benign, though headline inflation may firm up toward the 6 per cent upper tolerance level in Q3 FY27 before supply shocks wane in Q4.

Current Account Deficit

The SPF sees the current account deficit widening to 2.1 per cent of GDP in FY27 (up from an earlier estimate of 1.5 per cent), before it is expected to moderate to 1.2 per cent in FY28.

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MACRO SNAPSHOT

• Panel sees two hikes of 25 basis points in FY27.
• RBI projected a slightly higher 6.6 per cent GDP growth outlook.
• Repo rate expected to rise from 5.25 to 5.75%.
• The current account deficit is seen widening to 2.1 per cent in FY27.
• Inflation is expected to ease to 4.5 per cent in FY28 projections.

India, Indonesia eye deeper ties in defence, semicon

New Delhi: External Affairs Minister S Jaishankar hosted his Indonesian counterpart Sugiono for wide-ranging talks on Sunday, exploring ways to deepen cooperation in areas of defence, maritime trade, investments, pharmaceuticals, semiconductors and food security. Sugiono is currently on a three-day visit to New Delhi. In a post on ‘X’, Jaishankar said the India-Indonesia Comprehensive Strategic Partnership has witnessed strong growth in recent years.

Global airlines slash profit forecast for 2026 over Iran war fuel shock

The global airline industry nearly halved its 2026 profit forecast on Sunday, citing conflict in West Asia that has driven up fuel costs, disrupted key air corridors and exposed the fragility of a sector operating on thin margins.

The International Air Transport Association (IATA), which represents more than 370 airlines accounting for about 85 per cent of global air traffic, said in its annual report that it now expects the industry to post a combined net profit of $23 billion in 2026. This is well below a previous projection of about $41 billion and down from $45 billion in 2025. The downgrade underscores the vulnerability of airlines to geopolitical shocks and fuel volatility, even as passenger demand remains resilient and revenues are projected to rise above $1.1 trillion.

Key Factors for the Downgrade

IATA Director General Willie Walsh, speaking at the group’s annual meeting in Rio de Janeiro, cited two primary reasons for the reduced forecast:

• Surging Fuel Costs: Significant increases in jet fuel prices that exceeded industry expectations.
• Regional Disruption: Continued disruption to airlines operating in the Gulf region.

Industry Outlook

Walsh expects some smaller airlines to face bankruptcy or acquisition by larger carriers as higher fuel costs take a toll. Notably, Spirit Airlines, a US low-cost carrier, shut down last month, becoming the first airline casualty attributed to the Iran war.

To protect margins, airlines are expected to cut unprofitable routes. Consequently, Walsh noted that fares are unlikely to fall soon. "In an environment where demand remains pretty robust, but capacity comes down, that will likely lead to a situation where fares will remain elevated," he explained.

IATA expects the global airline fuel bill to surge to approximately $350 billion this year, up from roughly $252 billion in 2025. Fuel is now expected to account for nearly a third of the industry's total operating costs.

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Reuters, Rio de Janeiro

‘Fiscal health index’ rewards prudence alone

FISCAL HEALTH. Quality of spending matters. Developed States that historically have high social spending are unfairly ranked lower on the fiscal health charts

By Christopher Sujoy Thomas, Niranjana VH, and Sumalatha BS

The NITI Aayog has published two editions of its Fiscal Health Index (FHI), using audited Comptroller and Auditor General (CAG) data for the financial years 2022-23 and 2023-24. This index benchmarks the fiscal performance of India's 18 major general category states.

State Performance Trends

A comparative analysis of the two editions reveals significant shifts in state rankings:

• Odisha: Maintained its "achiever" position, increasing its score from 67.8 to 73.1.
• Goa and Haryana: Both showed improvement, with Haryana moving from the "aspirational" to the "performer" tier.
• Jharkhand: Its score dropped from 55.2 to 44.3, resulting in a downgrade from "achiever" to "front runner".
• Karnataka and Telangana: Both were downgraded to the "performer" tier.
• Tamil Nadu: Faced a major drop, moving from "performer" to the "aspirational" tier.
• Kerala: Remained in the bottom "aspirational" category.

The ‘Southern Fiscal Paradox’

The index reveals a broadening paradox where states with traditionally high social spending appear disadvantaged, while fiscally restrained states receive higher rankings. This raises questions about whether the FHI truly measures fiscal health or merely rewards fiscal restraint—penalizing states for spending and borrowing.

The GSDP Denominator Trap

A core issue is the use of Gross State Domestic Product (GSDP) as a denominator for sub-indicators like capital outlay, fiscal deficit, and outstanding liabilities. This structurally benefits mineral-rich states like Odisha, where rapid GSDP growth automatically improves ratios even if absolute fiscal performance is unchanged. Conversely, states with slow GSDP growth are penalized even if they increase essential capital expenditure.

Revenue Mobilization Discrepancies

The measurement of revenue mobilization merges tax revenue with geographical non-tax revenues, such as mining royalties in Odisha or PSU dividends in Chhattisgarh. Since states cannot "manufacture" mineral deposits, these rankings often reflect geological advantages rather than superior tax administration or fiscal effort.

Human Development vs. Fiscal Health

A striking structural outcome of the index is the inverse relationship between fiscal health and human development. Kerala and Tamil Nadu, undisputed leaders in literacy and life expectancy, occupy the bottom of the FHI, while states with lower human development outcomes, like Odisha and Jharkhand, occupy the top positions. Highly developed states carry the "fiscal legacy" of decades of social investment and often receive lower Central devolution despite contributing more to the national GDP.

Conclusion and Recommendations

While the FHI’s methodological consistency is a strength, the authors argue it requires modification. Instead of celebrating fiscal restraint in states with poor human development outcomes, these states should be encouraged to spend more on social development. The FHI should be linked to socio-economic development rather than relying solely on fiscal indicators.

Cooling inflation with forex inflows

Amid the brewing external and internal troubles, the weakening currency is acting as a catalyst for inflation

By Devendra Kumar Pant and Megha Arora

The backdrop for the June 2026 monetary policy was the uncertain global economy, high energy prices, sharply depreciating currency and the threat of El Niño. The collective impact of these factors on the Indian economy is higher inflation and lower growth.

The RBI, on expected lines, has maintained a status quo on the policy rate and retained the neutral stance. While energy prices have risen sharply, the pass-through to consumers for mass consumption items such as petrol and diesel started only from mid-May, before being revised upwards four times. To minimise the losses to oil marketing companies, the pump prices of petroleum products may be revised in the future as well. In the June monetary policy, the growth estimate for FY27 has been revised downward to 6.6 per cent from 6.9 per cent, and the inflation forecast revised upward to 5.1 per cent from 4.6 per cent.

RBI Governor Sanjay Malhotra has acknowledged that the risks of higher inflation have amplified; however, the banking regulator will wait for greater clarity before acting on rates. Future rate actions would be data dependent.

The Rupee and Forex Reserves

Currently, one of the major headwinds for the Indian economy is the weakening of the rupee vis-à-vis the dollar. The dollar-rupee depreciated 3.1 per cent since the last policy (April 8) and 6 per cent since the beginning of the year. The weaker currency is acting as a catalyst for inflation. The key reasons for this include the continuous outflows from foreign portfolio investors (FPIs). India’s forex reserves at end-May declined to $682.32 billion, which is $14.8 billion lower than on April 3. Consequently, the June monetary policy focused on improving capital flows into the economy.

G-Sec Limit

In a coordinated move, the government has tweaked the tax policy for FPIs. To attract more investment into the government security market, the list of securities under the fully accessible route (FAR) now includes G-Sec of 15-, 30- and 40-year tenor and sovereign green bonds. Restrictions on short-term investment and concentration-wise limits on FPIs have been removed; they now fall under an overall investment limit of 6 per cent of the outstanding stock of G-Sec and 2 per cent of State government securities.

As of June 5, the unutilised general limit was ₹5.59 lakh crore ($58.57 billion). These tax policy changes are intended to attract more investment in government securities to support the currency.

Additional Measures

The RBI announced further measures to augment forex reserves:

• An increase in the investment limits for non-resident Indians (NRIs) and overseas citizens of India (OCIs) in traded assets.
• A US dollar-rupee swap provided to public sector undertakings (PSUs) until end-September.
• Full hedging for authorised dealer banks to raise 3-5 year FCNR(B) deposits, with costs borne by the RBI.
• Restoring the timeline for realisation of export proceeds to nine months.

Outlook on Inflation and Rates

The forex inflow due to the tax relief for FPIs will depend on India's risk perception and comparative dollarised returns. Since withholding tax was a major reason for India’s non-inclusion in global bond indices, these measures are expected to support capital inflows.

While inflation in 3QFY27 (5.9 per cent) may be close to the RBI's 6 per cent upper tolerance level, it is expected to decline to 5.4 per cent in 4QFY27. The wording of the policy statement suggests a possible increase in the policy rate in the future.

The authors' base case is a hold on policy rates in the next monetary policy (August), driven by the expected decline in inflation in 4QFY27. However, if the monsoon rainfall deviation exceeds 10 per cent, or if the war continues longer and oil prices remain high, the RBI may take policy action even before the next scheduled meeting.

LINE & LENGTH. The dilemmas of Modi govt

The 12-year-old Modi government is looking jaded. Will voter boredom lead to a change in government in the next elections?

By TCA Srinivasa Raghavan

There comes a time in the life of governments, especially long-running ones, when after a great run they suddenly appear helpless, incompetent, and bumbling. They appear to be "on the skids," sliding down in an uncontrollable way. This problem must now be seriously confronted in respect of the 12-year-old Modi government.

External Pressures and Shocks Troubles for the government began last summer when Donald Trump, irritated that India gave him no credit for ending a three-day war with Pakistan, turned on India by increasing tariffs to "ridiculous levels". This caught the government completely unawares. This was followed by the American-Israeli war with Iran, which caused a sharp drop in oil and gas supplies from the Middle East.

Furthermore, since January, there has been a sustained withdrawal of foreign investment in the stock market amounting to about $25 billion. The rupee has depreciated by over 10 per cent against the dollar over a year, forcing the government into a "climb down" by fiddling with rules determining rates of return on foreign investment to stabilize volatility.

Economic and Domestic Headwinds Domestically, the monsoon looks like it won’t be normal due to an building El Niño. There are also critical shortages of fertilizer and fuel, leading to a strong possibility of a sharp increase in inflation. While these global issues are influenced by external actors like Trump, the length of time this government has been in power is becoming a factor.

The Challenge of Anti-Incumbency The central question is whether the country is reaching a stage where people prefer "anyone other than you". While the Modi government may not be at that point yet, massive anti-incumbency takes time to marinate. Newcomers like AAP and TVK could cause upsets if the electorate becomes fed up. Historical precedents show that even leaders of immense stature, like Indira Gandhi and Rajiv Gandhi, can fall from "hero to zero" when they annoy enough people. In 1967, the Congress lost over two-thirds of state legislatures, and in 2011, it dropped to just 44 seats in Parliament.

Political Mathematics The BJP currently has a solid base of about 220–230 seats, but in this Parliament, it holds only 240 seats and is in a small coalition. If it drops another 25 seats—which is not inconceivable—it will require a much larger coalition.

Voter Boredom The mood of the voters may shift to "let’s give someone else a chance". After 12 years, the government is looking jaded, reminiscent of a Cabinet Minister in 2013 who remarked that they were tired and it was time to "watch the river flow by". The combination of Trump tariffs, the Iran war, energy disruptions, and a bleak monsoon all point toward economic pain that could lead voters to seek alternatives.

A pragmatic monetary policy

By K Srinivasa Rao

While the market had well anticipated the repo rate and policy stance remaining unchanged in the monetary policy, the RBI's business intelligence script will play a key role in guiding sectors to develop strategies to withstand geopolitical risks in trying times and sustain the growth trajectory.

The data-driven economic outlook projected in the monetary policy can be a critical input in shaping domestic and international market sentiment, even as rising energy prices, a subnormal south-west monsoon, and the El Niño effect could weigh on economic activity. Besides the regular flow of credit, banks can take cues and explore opportunities such as ECLGS 5.0 and the enhanced scope of CGTMSE to reach out to stressed sectors. It provides clear direction to regulated entities to augment foreign capital by exploring newly opened gateways to strengthen foreign exchange reserves.

In the given uncertain state, the design and monetary policy architecture is a pragmatic, stimulating tool for stakeholders to better manage heightening geopolitical risks. Overall credit growth was 15.4 per cent in FY26, up from 12.1 per cent in FY25, and broad-based bank credit growth stood at 16.2 per cent as of May 15, 2026, up from 9.8 per cent a year ago, providing comfort to stakeholders.

To shore up forex reserves, now at $682.3 billion, the RBI rolled out a package of measures to attract new forex inflows and reiterated that it will ensure an orderly, market-driven movement of the INR and keep a close watch on it. Despite heightened uncertainty and disruptions to trade routes and supply chains due to lingering conflict in West Asia, the economy is well-poised to grow, though slightly below the earlier estimate.

The shades of collateral risks can be better perceived from its future outlook on growth-inflation dynamics. Against the backdrop of 7.6 per cent GDP growth in FY26, the RBI has now revised its projection downward to 6.6 per cent, and average inflation could inch up to 5.1 per cent in FY27. Notwithstanding external sector risks, the RBI is confident it can contain inflation well within its glide path.

Amid steady system liquidity since the last monetary policy and RBI's continued assurance of adequate liquidity in the banking system to meet productive needs, the weighted average call rate (WACR) has fluctuated within the corridor of 5 per cent (SDF) to 5.5 per cent (MSF).

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The writer is Adjunct Professor, Institute of Insurance and Risk Management (IIRM), Hyderabad. Views expressed are personal.

George Lucas and Christopher Nolan: Building the Galaxy

 

OECD Economic Outlook June 2026: Under Pressure

 The conflict in the Middle East has emerged as the dominant force shaping the global economic outlook in mid-2026. While the world economy initially showed resilience through strong investment in artificial intelligence and easing trade tensions, it is now "under pressure" from severe disruptions to regional shipments and infrastructure.

Core Economic Disruptions

The impacts are primarily driven by damage to energy infrastructure and the near-halt of shipments through the Strait of Hormuz.

• Energy Supply: Global oil supply fell by 13.5% between February and April 2026, with Gulf production alone dropping by 45%. LNG exports from the region, notably from Qatar, have also halted due to production facility damage.
• Commodity Prices: Prices for crude oil, natural gas, sulphur, and fertilisers (like urea) have ratcheted upward.
• Trade and Logistics: Strait of Hormuz transits remain a fraction of pre-conflict levels, leading to severe port congestion in areas like Oman and the Red Sea. Global ocean freight rates have risen approximately 45% above pre-conflict levels.
• Industrial Inputs: The region is a critical source for methanol, ammonia, and helium. Helium is particularly vital for semiconductor manufacturing, meaning disruptions could eventually hinder AI infrastructure development.

Scenario-Based Outlook

Recognizing high uncertainty, the sources present two possible trajectories for the global economy:

1. Time-Limited Disruption Scenario: This assumes energy production and trade return to pre-conflict levels from the third quarter of 2026. Under this path, global GDP growth is projected to slow from 3.4% in 2025 to 2.8% in 2026 before recovering to 3.1% in 2027. Inflation in G20 countries would rise to 4.0% in 2026.
2. Prolonged Disruption Scenario: If disruptions persist into late 2027, global growth could plummet to 2.1% in 2026 and 1.8% in 2027, pushing some economies toward recession. In this case, global inflation would see significant upside pressure, rising by an additional 1.3 percentage points in 2027.

Impact on Specific Regions and Sectors

The burden of the conflict is not distributed evenly:

• Asian Economies: These are among the most exposed due to their heavy reliance on Persian Gulf energy imports. Countries like Thailand, Korea, and India have particularly high direct and indirect exposure.
• Developing Economies: Commodity-importing developing nations face severe risks, as they often lack the fiscal capacity to cushion households against price shocks and have weaker social safety nets.
• Agriculture: Higher fertiliser prices and supply disruptions threaten global crop yields and food security, with grain prices expected to remain higher for longer than the duration of the conflict itself.
• AI and Technology: Prolonged energy shortages would increase data center operating costs—energy accounts for 60% of these costs—and potentially delay large-scale AI infrastructure projects.

Policy Recommendations

The OECD emphasizes that flexible and agile policies are required to ensure stability.

• Fiscal Policy: Governments should provide relief to households and firms, but measures should be temporary and well-targeted to avoid excessive fiscal costs and preserve incentives to reduce energy use.
• Energy Resilience: The crisis underscores the urgent need to diversify energy supplies and improve energy efficiency to "wean" economies off dependency on fossil fuel imports from single chokepoints.
• Monetary Policy: Central banks must remain vigilant; while they may "look through" temporary supply-driven price rises, they must act if inflation expectations become de-anchored or growth weakens substantially.

Recognizing the exceptional uncertainty surrounding the conflict in the Middle East, the June 2026 OECD Economic Outlook frames global projections through two distinct trajectories for the next eighteen months. These scenarios are primarily conditioned on the duration of disruptions to energy production and trade routes in the Persian Gulf.

1. Time-Limited Disruption Scenario (Projections-Based)

This scenario assumes that the disruptions caused by the conflict are significant but relatively short-lived.

• Conflict Resolution: It assumes progress toward a negotiated peace agreement, with energy production and regular shipping routes returning to pre-conflict levels starting in the third quarter of 2026.
• Growth Path: Global GDP growth is projected to moderate from 3.4% in 2025 to 2.8% in 2026, before recovering to 3.1% in 2027.
• Inflation: Consumer price inflation in the G20 is expected to rise to 4.0% in 2026 (up from 3.4% in 2025) before easing to 3.1% in 2027 as energy and food price pressures fade.
• Policy Stance: Central banks are generally expected to keep policy interest rates broadly stable through 2026 before easing slightly in 2027. The fiscal stance remains broadly neutral in most countries during 2026.
• Mitigating Factors: Strong underlying momentum from AI-related investment, resilient household balance sheets, and a reduction in effective US tariff rates are expected to support near-term growth.

2. Prolonged Disruption Scenario (Model-Based)

This scenario highlights the severe costs if a peace agreement is not secured until late in 2027.

• Market Shocks: Energy production remains subdued, and oil, gas, and fertiliser prices are assumed to rise by 50% relative to the time-limited scenario from Q3 2026 to Q3 2027.
• Global Recession Risks: Global growth would plummet to 2.1% in 2026 and 1.8% in 2027, potentially pushing several major economies into or close to recession.
• Higher Inflation: Global inflation would see significant upside pressure, rising by an additional 1.3 percentage points in 2027.
• Scarring Effects: The sustained period of lower energy supply and higher costs would lead to lower potential output starting in 2028 due to foregone investment and reduced efficiency.
• Financial Impact: This path involves a renewed tightening of financial conditions, a 15% decline in global equity prices, and an increase in risk premia.

Comparative Impacts and Specific Risks

The difference between these scenarios underscores the global economy's vulnerability to regional chokepoints.

• Regional Exposure: Many Asian economies face the heaviest impact in the prolonged scenario due to their high direct and indirect reliance on Persian Gulf energy.
• Industry Vulnerability: A prolonged conflict could specifically hinder the AI sector by increasing data center operating costs and disrupting the supply of critical hardware and specialized inputs like helium.
• Food Security: Persistent disruptions to fertiliser exports (like urea and ammonia) could lead to lower crop yields and substantial food price inflation well into 2027, particularly hurting developing nations.

Policy Implications

The Outlook emphasizes that "Under Pressure," policymakers must remain flexible and agile. Under the time-limited scenario, central banks can "look through" temporary price rises. However, in the prolonged scenario, many central banks would likely have to raise policy rates (by 50-75 basis points) to anchor inflation expectations, even as growth weakens. Fiscal policy would then face the primary burden of cushioning the downturn, despite already elevated public debt levels in many nations.

The global economy entered 2026 with more resilience than anticipated, driven by strong investment in artificial intelligence (AI), supportive financial conditions, and a temporary easing of trade tensions. However, the onset of the conflict in the Middle East has placed the global system "under pressure," primarily through severe disruptions to energy production and trade routes.

Growth and Inflation Projections

The OECD frames the outlook through two primary macroeconomic trajectories based on the duration of Middle East disruptions:

• Time-Limited Disruption: Under the assumption that energy production and shipping normalise by the third quarter of 2026, global GDP growth is projected to slow from 3.4% in 2025 to 2.8% in 2026, before a modest recovery to 3.1% in 2027. Inflation in G20 countries is expected to rise to 4.0% in 2026 due to the energy shock before easing to 3.1% in 2027.
• Prolonged Disruption: Should disruptions persist into late 2027, global growth could plummet to 2.1% in 2026 and 1.8% in 2027, potentially pushing several major economies into or near recession. In this scenario, global inflation would see significant upside pressure, rising by an additional 1.3 percentage points in 2027.

Key Drivers of Economic Pressure

Macroeconomic developments are currently dominated by several supply-side shocks and shifting fiscal priorities:

• Energy and Commodity Spikes: Global oil supply fell by 13.5% between February and April 2026, with Gulf production alone dropping by 45%. This has led to sharp increases in the prices of crude oil, natural gas, and fertilisers (like urea and ammonia).
• Trade and Logistics: Transits through the Strait of Hormuz remain severely restricted, leading to significant port congestion in the Red Sea and Oman. Global ocean freight rates have risen approximately 45% above pre-conflict levels.
• AI-Related Resilience: Despite these pressures, underlying momentum has been sustained by AI-related investment, particularly in the United States and advanced Asian economies. However, prolonged energy shortages could eventually raise data centre operating costs and disrupt the supply of critical hardware.
• Labour Markets: Employment conditions remain generally stable with low unemployment by historical standards, but real wages have been hit hard by the renewed spike in inflation, with one-third of OECD economies projected to have negative real wage growth in 2026.

Financial Conditions and Debt

Financial conditions have tightened since the onset of the conflict amid higher market volatility.

• Asset Pricing: Sovereign bond yields and corporate spreads have increased, reflecting expectations of higher inflation and risk premia.
• Corporate Debt: Total corporate debt in G20 economies remains high at roughly 90% of GDP. Significant refinancing needs are emerging just as borrowing costs rise, posing risks to firms with weaker balance sheets.
• NBFI Vulnerabilities: There are growing concerns regarding non-bank financial institutions (NBFIs), specifically private credit and equity funds, which have high exposure to the technology sector and face potential liquidity mismatches.

The Rising Impact of Defence Spending

A significant macroeconomic shift is the rapid, synchronised rise in defence spending across OECD nations.

• Fiscal Pressure: NATO members are moving toward a target of 3.5% of GDP for core defence spending by 2035.
• Economic Impact: While providing a modest near-term boost to activity in countries with domestic military production capacity, higher defence outlays add to public debt pressures and may crowd out private investment or other public spending (such as on climate or education) over the long term.

Policy Recommendations

The Outlook emphasizes that "flexible and agile" policies are required. Central banks must remain vigilant; while they may "look through" temporary supply-driven price rises, they must act if inflation expectations become de-anchored. Fiscal policy should provide targeted relief to vulnerable households but must also establish a credible path to long-term debt sustainability in the face of ageing populations and rising defence needs.

The financial landscape in mid-2026 is characterized by significant vulnerabilities that have been exacerbated by the conflict in the Middle East, placing global stability "under pressure." While financial conditions initially remained accommodative, the escalation of the conflict has triggered tighter conditions, higher market volatility, and a substantial repricing of assets.

Corporate Debt and Refinancing Strains

Total corporate debt in G20 economies remains historically high at approximately USD 90 trillion, or 90% of GDP. Firms now face a "maturity wall," with one-quarter of this debt set to mature within the next three years.

• Rising Costs: Much of this debt was issued during the low-rate period of 2018-21; firms must now refinance at significantly higher costs, with nearly half of outstanding investment-grade bonds carrying rates above 4%.
• Refinancing Risks: For financially weak issuers, prolonged energy disruptions and weaker growth could constrain access to credit, potentially lifting global speculative-grade default rates.

Vulnerabilities in Non-Bank Financial Institutions (NBFIs)

The rapid growth of the private capital market—now estimated at USD 22 trillion—has introduced new systemic risks.

• Private Credit and Equity: These funds have grown to USD 15 trillion in assets but face increasing concerns regarding liquidity mismatches and asset quality. Some large US private credit funds have already faced increased write-downs in 2026, leading to investor redemption requests and subsequent actions to limit those redemptions.
• Tech Exposure: Private equity and credit funds are heavily concentrated in the technology sector; software alone accounts for 42% of new US private equity investments in 2025.
• Interconnectedness: Banks have increasingly ceded lending activity to these alternative lenders and have simultaneously expanded their own lending to NBFIs. This creates a "leverage on leverage" effect that could amplify shocks through simultaneous deleveraging and fire sales.

Risks in the AI Sector

The rapid expansion of the artificial intelligence sector is creating specific financial fragilities.

• Valuation Risks: High valuations for AI stocks leave them vulnerable to correlated valuation shocks if expected returns fail to materialize.
• Opaque Financing: AI firms increasingly rely on less transparent private capital and "circular financing" arrangements, where AI firms act as both borrowers and creditors to one another.
• Energy Sensitivity: Because AI infrastructure (like data centers) is highly energy-intensive, the sector is uniquely sensitive to the energy price spikes caused by the Middle East conflict.

Sovereign Debt and Financing Shocks

Sovereign bond yields have risen across most markets due to higher inflation expectations and risk premia.

• Investor Base Shift: There has been a marked shift in who holds government debt, moving from central banks to more price-sensitive private investors, such as hedge funds. This transition increases the risk of financing shocks if investor sentiment shifts abruptly.
• Debt Sustainability: In many countries, current fiscal balances fall short of what is needed to stabilize debt ratios, especially as spending pressures rise for defence, ageing populations, and the green transition.

Scenario-Specific Financial Impacts

In the prolonged disruption scenario, where the conflict lasts well into 2027, the sources project a severe tightening of financial conditions:

• Equity Markets: A projected 15% decline in global equity prices.
• Risk Premia: Investment risk premia could rise by 75 basis points in advanced economies and 100 basis points in emerging markets.
• Default Risks: Sustained high energy costs and weak demand would likely lead to a sharp increase in corporate defaults and a significant scaling back of business investment.

To manage the global economy while it is "under pressure" from the Middle East conflict, the OECD recommends a suite of "flexible and agile" policies. These recommendations balance immediate crisis management with the need for long-term fiscal sustainability and structural resilience.

Monetary Policy: Vigilance and Anchoring Expectations

Central banks are advised to remain vigilant and attentive to shifting risks.

• "Looking Through" Shocks: Central banks can generally "look through" temporary supply-driven price rises if inflation expectations remain well-anchored.
• Rate Adjustments: Policy adjustments will be necessary if price pressures broaden (as in the prolonged disruption scenario) or if growth weakens significantly.
• Liquidity Support: If global financial conditions tighten severely, central banks should consider enhancing currency swap lines and reconsidering plans to reduce sovereign bond holdings.

Fiscal Policy: Targeted Relief and Sustainability

Fiscal space is constrained by elevated public debt and rising spending pressures from ageing, defence, and the green transition.

• Energy Relief: Support for households and firms should be well-targeted toward those most in need to contain fiscal costs and preserve incentives for energy conservation.
• Sunset Clauses: Measures should include automatic sunset mechanisms to ensure they are phased out once energy prices decline.
• Sustainability Path: Governments must establish a credible fiscal path to debt sustainability, requiring efforts to improve public sector efficiency and reallocate spending toward growth-enhancing investments.

Energy Security: Diversification and Efficiency

The vulnerability of global economies to a single chokepoint (the Strait of Hormuz) necessitates urgent shifts in energy policy.

• Diversification: Governments must intensify efforts to diversify energy supplies and reduce reliance on fossil fuel imports from single chokepoints.
• Efficiency and Electrification: Improving energy efficiency through regulatory standards and accelerating the electrification of end-uses are key to structural resilience.
• International Coordination: In the near term, international coordination of strategic energy stocks and emergency demand-restraint measures can help mitigate supply crunches.

Financial Stability: Addressing New Vulnerabilities

The OECD highlights the need for robust supervision to safeguard the financial system.

• NBFI Oversight: Progress is needed on regulatory policies for non-bank financial institutions (NBFIs) and crypto-assets.
• Enhanced Stress-Testing: Stress-tests should explore the potential effects of long-lasting Middle East disruptions and marked changes in AI valuations given the increasing interconnectedness between banks and NBFIs.

Structural Reforms and Trade

To improve medium-term growth prospects, the OECD suggests several reform priorities:

• Reducing Barriers: Actions to reduce regulatory burdens, simplify insolvency procedures, and promote product market competition.
• Labour and Skills: Policies to strengthen skill development, expand lifelong learning, and reduce tax wedges to promote labour mobility and participation.
• Trade Policy: Countries should avoid new export restrictions, which exacerbate global shortages, and instead engage in constructive dialogue to resolve trade tensions.

Defence Spending: Efficiency and Coordination

With defence spending rising toward a NATO target of 3.5% of GDP, the OECD emphasizes efficient resource management.

• Procurement Reform: Governments should improve procurement practices to reduce waste and harness competition.
• International Cooperation: Coordination in military purchases, particularly in Europe, could enlarge markets for productive firms and support interoperability.

Intertemporal Substitution and Household Consumption: Evidence from Structural Shocks

 The central thesis of the provided research is that households do not substitute consumption intertemporally in response to changes in real interest rates. While standard macroeconomic models assume that households adjust their spending paths to take advantage of higher interest rates (saving now to consume more later), the source finds no empirical evidence for this behavior across ten different structural shocks. Instead, the data suggests that aggregate consumption responses are almost entirely driven by changes in the expected path of labor income.

The Context of Intertemporal Substitution

In traditional macroeconomic theory, households are expected to "smooth" their consumption over time. This behavior is governed by the elasticity of intertemporal substitution (EIS), which measures how sensitive consumption growth is to changes in the real interest rate. If the EIS is positive, a rise in interest rates should theoretically induce households to reduce current consumption to increase future consumption.

However, the source highlights a long-standing "lack of evidence" for this sensitivity:

• Historical Precedent: Seminal research by Hall (1988) previously found no strong relationship between interest rates and consumption growth, suggesting the EIS may be zero.
• Near Rationality: The source notes that for many households, the utility gain from perfectly optimizing consumption based on interest rate fluctuations is extremely small—potentially as little as $0.08 to $1.45 per quarter. Consequently, it may be "rational" for consumers to ignore interest rates entirely.
• Popular Advice: Interestingly, popular financial advice books rarely, if ever, advise households to change their spending patterns based on interest rate movements, focusing instead on saving fixed fractions of income.

The Author’s Identification Strategy

To isolate the role of intertemporal substitution, the author uses a "consumption block" approach, which allows for estimation without needing to specify the entire structure of the economy. The methodology relies on:

• Structural Shocks: The author examines 10 different types of shocks—including monetary policy, government spending, and technology shocks—some of which produce large, persistent changes in real interest rates.
• Consumption Jacobians: These are "sufficient statistics" used to map how consumption responds to four specific inputs: labor income, the real fed funds rate, stock returns, and real estate returns.
• Sticky Expectations: By incorporating a parameter for "sticky expectations," the author ensures that the observed lack of response isn't simply an artifact of households being slow to process new information.

Findings and Evidence

The core result is that the estimated parameter for intertemporal substitution is statistically indistinguishable from zero for all ten shocks examined.

• Income as the Primary Driver: In every shock series, the "income component" of the consumption response is the dominant factor. For example, in the Romer and Romer (2004) monetary policy shocks, the rise in consumption is explained by the gradual rise in labor income, not the drop in interest rates.
• The Failure of Substitution Models: When the author applies a standard model with "rational expectations" (assuming an EIS of 1), the predicted consumption response moves far outside the confidence intervals of actual empirical data.
• Robustness: These findings remain consistent even when the author tests different values for the elasticity of substitution or uses alternative models like "finite horizon planning".

Implications for Economic Theory

This evidence challenges the "pivotal factor" role that intertemporal substitution plays in many macroeconomic models. If consumption does not respond to interest rates, it suggests that monetary policy may transmit through the economy differently than previously thought—perhaps primarily through its impact on investment or by directly altering household income through labor market channels rather than through the traditional "substitution" incentive.

The methodology employed in the provided research focuses on isolating the "consumption block" of macroeconomic models to determine if households actually shift their spending in response to real interest rate changes. By narrowing the scope to this specific block, the author can remain agnostic about the rest of the model (such as firm-side frictions or price-setting mechanisms), allowing for the use of a wider range of structural shocks than traditional general equilibrium models.

The following sections detail the specific components of this methodological approach:

1. The Input-Output Framework (Consumption Jacobians)

The author treats the consumption decision as an input-output structure where the dynamics are fully described by consumption Jacobians. These Jacobians are "sufficient statistics" that map how aggregate consumption at time $t$ responds to a marginal change in an input at time $s$.

• Inputs: The expected paths for aggregate labor income, the real federal funds rate, and real returns on stocks and real estate.
• Outputs: Aggregate consumption and savings.

2. Use of Structural Shocks for Identification

To overcome the challenge of interest rates co-moving with other economic factors, the author utilizes 10 different structural shocks identified in existing literature (Ramey, 2016). These include monetary policy surprises, defense spending news, tax shocks, and technology shocks.

• The strategy relies on finding shocks that affect consumption only through their impact on income and asset returns, rather than through changes in household preferences (discount factors).
• By using ten distinct shocks, the researcher aims to provide "overwhelming" aggregate evidence that is not sensitive to a single identification method.

3. Two-Step Estimation Process

The methodology follows a precise two-step process to calculate the role of intertemporal substitution:

• Step 1: Local Projections. The author uses local projections to calculate empirical impulse response functions (IRFs) for every input (income, interest rates, asset prices) and for consumption itself across all ten shocks.
• Step 2: Minimum-Distance Estimation. The author then calculates a "Jacobian-implied" consumption IRF by summing the four Jacobians multiplied by the empirical inputs. A distance metric is used to find the parameters that minimize the difference between this theoretical response and the actual empirical consumption response observed in the data.

4. Incorporating Sticky Expectations

A critical feature of the methodology is the inclusion of a parameter for sticky expectations. This ensures that if households appear unresponsive to interest rates, it is not simply because they are slow to process new information or sluggish in belief updating. By explicitly modeling this friction, the author can more rigorously test if the near-zero response is a "genuine lack of intertemporal substitution" rather than a delay in reaction.

5. Key Assumptions and Limitations

• Separability of Labor and Consumption: The methodology assumes that the consumption-saving decision can be separated from the labor decision through aggregate labor income. This assumption might not hold if leisure and consumption are not separable in the household's utility function.
• Linearization: The model is limited to analyzing small deviations around a steady state and does not account for time-varying risk premiums or state-dependent responses.
• Asset Income Effects: Because households' primary assets (stocks/real estate) are not well-approximated by short-term bonds, the author discards the model-based interest rate income effect and replaces it with empirical estimates of consumption responses to asset price changes.

In the research provided, the consumption block is modeled as a specific input-output structure within the larger macroeconomy. The central thesis is that the dynamics of aggregate consumption can be fully described by how it responds to four specific inputs, mediated through "consumption Jacobians" which act as sufficient statistics for these responses.

The Four Primary Inputs

The sources identify the following as the essential inputs that determine the household consumption decision:

• Aggregate Labor Income: This is the most significant input for determining actual consumption behavior. The author specifically defines this as the sum of employee compensation, proprietors' income, and transfers, minus specific taxes and social security contributions.
• Real Federal Funds Rate: This input is the theoretical centerpiece of intertemporal substitution. It is measured as the nominal federal funds rate minus one-year-ahead expected inflation. Standard theory suggests that changes in this input should incentivize households to shift consumption across time.
• Real Returns on the Stock Market: This input helps capture the "income effect" of wealth. It uses inflation-adjusted prices from Fama French.
• Real Returns on Real Estate: Similarly used for the income effect, this input is based on the Case-Shiller house price index adjusted for inflation.

Inputs in the Context of Intertemporal Substitution

The methodology uses these inputs to isolate why households change their spending. Theoretically, if the elasticity of intertemporal substitution (EIS) is positive, the "Real Federal Funds Rate" input should be a major driver of consumption fluctuations.

However, the sources reveal a disconnect between theory and empirical data regarding these inputs:

• Dominance of the Income Input: Across ten different types of structural shocks (such as monetary policy or technology shocks), the labor income path explains almost the entire aggregate consumption response. Even when interest rate inputs move significantly and persistently, they fail to induce a corresponding shift in consumption.
• The Residual Role of Interest Rates: The author calculates the effect of interest rates as a residual—the change in consumption that remains after accounting for the responses to income and asset prices. In practice, this residual is found to be close to zero, suggesting that the interest rate input has a negligible effect on household timing.
• Asset Inputs as Refinements: The sources explicitly replace the "income effect" of interest rates found in simple models with the stock and real estate inputs. This is because most household wealth is held in these assets rather than the short-term bonds typically used in Euler equation models. Despite this more realistic calibration, these asset inputs are found to play a negligible role in consumption responses compared to labor income.

Key Methodological Assumption

The validity of using these inputs relies on a "Key Assumption": that the aggregate consumption response is a function only of these four inputs (income, interest rates, and asset returns) and other factors independent of the shocks being analyzed. This allows the researcher to be agnostic about the rest of the economy—such as how firms set prices or how the government balances its budget—so long as those factors only affect households through these four specific channels.

In the source material, the author utilizes 10 distinct structural shocks to investigate whether households adjust their consumption timing in response to changes in real interest rates. These shocks, selected from the comprehensive review by Ramey (2016), serve as the primary tool for identifying the role of intertemporal substitution because they induce varied and often persistent fluctuations in real interest rates.

The analyzed structural shocks are categorized into three main areas:

1. Monetary Policy Shocks

The author examines two prominent methods for identifying monetary policy surprises:

• Romer and Romer (2004): Shocks are identified by the residual of the federal funds target rate after accounting for the Federal Reserve’s internal "Greenbook" forecasts.
• Gertler and Karadi (2015): This method uses high-frequency identification, looking at surprise changes in fed funds futures around Federal Open Market Committee (FOMC) announcements.

While these shocks lead to immediate drops in the real federal funds rate, the source finds that the resulting rise in consumption is almost entirely explained by a gradual rise in labor income rather than the interest rate change itself.

2. Fiscal Shocks

These shocks involve changes in government spending and anticipated tax policies:

• Military and Defense News: This includes military news shocks from Ramey and Zubairy (2018) and defense spending news from Ben Zeev and Pappa (2017). The latter is particularly informative because it produces a persistent negative real interest rate for four years.
• Government Spending: Blanchard and Perotti (2002) identify shocks through a recursive structure in a Vector Autoregression (VAR).
• Tax Shocks: These include "tax news" shocks from Mertens and Ravn (2011) and "expected taxes" from Leeper et al. (2012), the latter of which is derived from the spread between federal and municipal bonds.

3. Technology Shocks

The final category focuses on shifts in productivity and investment:

• Investment-Specific Technology (IST) News: Ben Zeev and Khan (2015) identify these through changes in the real price of investment.
• Total Factor Productivity (TFP): This includes utilization-adjusted TFP shocks from Fernald (2014) and unanticipated TFP shocks from Francis et al. (2014).

Findings in the Context of Intertemporal Substitution

The central finding across all ten shocks is that the estimated parameter for intertemporal substitution is statistically indistinguishable from zero. The source provides several insights into why these shocks support this conclusion:

• Failure of Traditional Models: If households behaved according to standard rational expectations models (with an elasticity of 1), the predicted consumption response to these shocks would fall far outside the empirical confidence intervals.
• Income as the Dominant Factor: In every shock series, the "income component" forms the bulk of the consumption response. For instance, despite the long period of lowered interest rates following a defense spending shock, households do not show the increased spending that intertemporal substitution theory would predict.
• Robustness of Evidence: By using a broad range of shocks—covering different identification methods and economic sectors—the author argues that the aggregate evidence against intertemporal substitution is "overwhelming" and not dependent on any single, potentially flawed identification strategy.

The theoretical framework of the source centers on isolating the "consumption block" of the economy to test the standard macroeconomic assumption that households smooth consumption by adjusting their spending in response to real interest rates. The author moves away from fully-specified general equilibrium models, instead using a framework that treats aggregate consumption as an input-output structure defined in sequence space.

1. The Consumption Block and Input-Output Structure

The framework assumes that the household decision-making process can be viewed as a sub-block of a larger model. The key theoretical assumption is that the impulse response of aggregate consumption is a function of specific expected paths: aggregate labor income, asset returns (stocks and real estate), and the real federal funds rate.

• Separability: This requires that the labor supply decision be separable from the consumption-saving decision, meaning leisure and consumption are not interconnected in the household's utility function.
• Agnosticism: Because the focus is strictly on this "block," the framework remains valid regardless of how other parts of the economy are modeled—such as price stickiness, international trade, or investment frictions—so long as they do not violate the block's internal logic.

2. Sequence Space and Consumption Jacobians

To describe the dynamics of this block, the framework utilizes "consumption Jacobians" as sufficient statistics.

• A Jacobian is a matrix that maps how aggregate consumption at time $t$ responds to a marginal change in an input (like income or interest rates) at time $s$.
• By linearizing the model around a steady state, the entire behavior of the consumption block is captured by four Jacobians—one for each primary input.

3. Decomposing the Interest Rate Effect

A critical component of the theoretical framework is the decomposition of the real interest rate Jacobian into two distinct effects:

• Intertemporal Substitution Effect: This measures how households shift the timing of consumption solely due to changes in the incentive to save (the Euler equation effect) while keeping the budget constraint fixed.
• Income Effect: This measures how changes in interest rates affect the household's feasible set of consumption plans (their wealth). The author discards the model-based income effect for interest rates—which often assumes households only hold short-term bonds—and instead uses empirical data for stock and real estate returns to capture the "true" wealth effects.

4. Micro-foundations and Behavioral Parameters

The framework is disciplined by a one-asset heterogeneous agent model (often called a buffer-stock model) where infinitely lived households face idiosyncratic income uncertainty and borrowing constraints.

• Sticky Expectations: The author incorporates a parameter for "sticky expectations" ($\theta$) to allow the model to span a range of behaviors, from full rational expectations to complete inattention. This ensures that a zero response to interest rates is interpreted as a genuine lack of substitution rather than a mere delay in processing information.
• Near Rationality: The framework draws on the theory of "near rationality," which suggests that the utility cost of failing to perfectly optimize consumption based on interest rate fluctuations is extremely low (cents per quarter). Theoretically, this makes it rational for households to ignore interest rate signals entirely and follow simpler rules of thumb, such as saving a fixed fraction of income.

5. Identification Strategy

The theoretical framework uses structural shocks as the identification tool. By selecting shocks orthogonal to household preferences (like technology or defense spending shocks), the author ensures that any observed change in consumption is a reaction to the inputs (income, rates, assets) rather than a shift in the households' internal discount factors. This allows for the estimation of the intertemporal substitution parameter as a residual after accounting for the well-documented effects of income and asset price changes.

The primary finding of the research is that households do not substitute consumption intertemporally in response to changes in real interest rates,,. Despite standard macroeconomic theories suggesting that households should shift their spending paths to take advantage of higher interest rates, the source find no evidence of this behavior across ten different types of structural shocks,,.

The key findings and their implications for the study of intertemporal substitution include:

1. Dominance of the Income Component

Aggregate consumption responses to economic shocks are driven almost entirely by changes in the expected path of labor income,,.

• In every shock examined—including monetary policy, defense spending, and technology shocks—the "income component" accounts for the bulk of the consumption response,.
• Movement in asset prices, such as stocks and real estate, plays a negligible role in determining aggregate consumption compared to labor income,.

2. Failure of Standard Macroeconomic Models

The source demonstrates a significant disconnect between empirical data and traditional "rational expectations" models:

• When a standard model with an elasticity of intertemporal substitution (EIS) of 1 is applied, it predicts consumption responses that fall far outside the 90 percent confidence intervals of actual empirical data,,.
• Even for shocks that produce large and persistent changes in real interest rates (such as defense spending news), households do not adjust their spending timing as the theory of intertemporal substitution predicts,,.

3. Robustness of the Near-Zero Estimate

The estimate that households do not intertemporally substitute remains consistent across various testing environments:

• Statistical Significance: For all ten structural shocks analyzed, the parameter for intertemporal substitution is statistically indistinguishable from zero,,.
• Model Variations: The findings are robust to different initial assumptions for the EIS, alternative behavioral frameworks like "finite horizon planning," and different calibrations of household wealth,,,.

4. Theoretical Justification: Near Rationality

The source provides a "near rationality" explanation for why households might ignore interest rate signals:

• The utility gain for a household that perfectly optimizes its consumption based on interest rate fluctuations is extremely small—estimated to be as little as $0.08 to $1.45 per quarter,.
• Because the cost of making a "mistake" by ignoring interest rates is so low, it is rational for consumers to focus on simpler rules, such as saving a fixed fraction of their income,.

5. Implications for Policy Transmission

The findings suggest that the traditional view of monetary policy transmission—where interest rates directly incentivize households to change their spending timing—may be incorrect. Instead, the source suggests that the effects of policy are likely transmitted through its impact on investment behavior or by indirectly altering household labor income.

Newspaper Summary 070626

 

The day all hedges fell in the US markets

TURBULENCE AHEAD. Markets grapple with the aftershocks of the AI sell-off, rising yields and mounting tensions in West Asia as fear grips investors

By Kumar Shankar Roy and Hari Viswanath (bl. research bureau)

Last Friday was a day when the logic of investing in uncorrelated assets broke down in the US markets. Most stocks fell, while semiconductor stocks crashed. Bonds declined as yields spiked. Gold and silver retreated. Crypto cracked. Crude oil slipped. The iShares MSCI South Korea ETF, traded in the US, tumbled 14.1 per cent. The only thing that went up — and no, that is not a bullish sign — was the VIX or CBOE Volatility Index which shot up nearly 40 per cent, implying fear was the only winner.

FEAR AND FRESH ISSUE

The trigger was not one shock but a pile-up. Results from Broadcom after market close on Wednesday triggered a rout in semiconductor stocks on Thursday and Friday. A solid 48 per cent year-on-year increase in its May quarter revenue was overshadowed by its July quarter outlook for AI chips, which fell short of investors’ lofty expectations.

Further, on Friday, the release of US jobs data for May which solidly beat forecasts added fuel to expectations that the US Fed is now likely to get hawkish amid high inflation and good job market (negates need for rate cuts). This pushed bond yields higher, with the 10-year Treasury yield moving above 4.5 per cent. These factors hurt the two trades that had dominated 2026: Long AI and rate-cut bets. When expensive growth stocks meet rising yields, even good stories need fresh oxygen.

Furthermore, market sentiment has soured over concerns that Big Tech firms may pivot from being buyers of their own equity to net sellers, as they divert capital to fuel their relentless AI infrastructure build-out. Alphabet, Google’s parent, last week moved to raise nearly $85 billion through an upsized equity plan to fund AI ambitions. On Friday, Facebook parent Meta’s stock fell after reports said it could raise tens of billions of dollars for its own AI push, though the company called the report speculation.

That shift matters. For years, cash-rich technology giants were machines of buybacks. Now, the AI build-out is so large that even the richest companies are testing the limits of internal cash flow and debt markets. As bond yields rise, expensive or overvalued equity can become the cheaper currency to fund the build-outs as compared to debt where interest rates are rising.

While Alphabet’s offering found strong bids, including from Berkshire Hathaway, concerns could build over a flood of supply hitting markets. Rumours of additional offerings from Big Tech come just as SpaceX is expected to launch a roughly $75-billion IPO next week. Add to this potential mega listings from Anthropic and OpenAI, and markets may have to brace for an unprecedented wave of equity issuance.

For example, the largest cash equity issuance before Alphabet’s offering was during the US government bailout of AIG, when Treasury bought $40 billion of newly issued preferred stock and took a 79.9 per cent stake in the company. The transaction size was unprecedented and massive but was warranted in a crisis situation. Alphabet’s capital raise is more than twice as large — and more could follow. Gold’s decline made its returns flat for the year against the dollar, while silver has slipped into negative territory.

Crypto did not offer an escape either. Bitcoin fell about 16 per cent for the week amid a record streak of spot bitcoin ETF outflows and a break from its dominant scarcity and institutional-demand narratives. Friday even saw bitcoin drop below $60,000, sinking to the lowest level since October 2024 taking its brutal drawdown to well over 50 per cent from all-time highs in 2024. Nor was the decline in oil a comforting signal. Prices fell on Friday, but global inventories are being rapidly drawn down as the Hormuz crisis escalates and the risk of a price spike remains.

MIND YOUR SURROUNDINGS

Among other concerns, the Japanese yen, which had been hovering near 40-year lows, is now weakening against the dollar at a time when inflationary shocks are spreading. While there is ongoing debate over whether yen carry trades have fully unwound, the risk remains that a major intervention by Japan to support its currency— similar to that seen in August 2024 — could create fresh pressure on global markets.

Going by the signals, it appears fear can spike further as tensions escalated over the weekend in the Middle East conflict. Unless there is any progress on the US-Iran stalemate, investors need to brace for more turbulence in the week ahead. The clearest signal comes from how Nikkei 225 Futures which closed on Friday down by a massive 5.6 per cent. All eyes will be on how Japan and Korea open on Monday, setting the tone for Indian markets. Investors need to heed what Henri Ducard tells Bruce Wayne in Batman Begins — ‘always mind your surroundings’.

Performance and portfolio composition of fund options

Under the NPS All Citizen Model, subscribers can invest in three asset classes through both Tier-I and Tier-II accounts: E (Equity), C (Corporate Debt) and G (Government Securities). NPS earlier offered a fourth asset class, ‘A’ (Alternate Assets), which invested in instruments such as Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs), but it was discontinued in December 2025 due to its limited investment universe. These exposures were integrated into E and C, which can now invest up to 5 per cent of their corpus in such instruments.

Equity (E)

Fund E allows managers to invest in stocks within the Nifty 250 and BSE 250 universes. Managers can also allocate up to 5 per cent of assets to REITs, InvITs, Category I and II Alternative Investment Funds (AIFs), and gold and silver ETFs. Based on 10-year rolling returns, Fund E has delivered an annualised return of 13.5 per cent, which is marginally below the Nifty 100 TRI’s 13.8 per cent.

Corporate Bonds (C)

This fund primarily invests in listed corporate debt issued by public sector enterprises and private companies. The permissible universe includes:

• PSU debt ETFs
• AT1 bonds
• Debt-oriented Category I and II AIFs

While Fund C primarily invests in securities rated AA and above, up to 10 per cent of assets may be allocated to bonds rated between A and AA-. Ten-year rolling return analysis shows Tier-I Fund C generated an average annualised return of 8.6 per cent, outperforming the 7.6 per cent delivered by direct corporate bond mutual funds.

Government Securities (G)

Fund G invests primarily in Central and State government securities with maturities ranging from one to 50 years. The portfolio's modified duration generally ranges between eight and 12 years. Over the long term, Fund G has posted an average return of 8.8 per cent, exceeding the 8.1 per cent return from direct gilt mutual funds.

Asset Allocation Decisions

Asset allocation is considered one of the most critical decisions for NPS subscribers.

• Younger investors: Can benefit from higher exposure to Fund E (capped at 75 per cent under active choice) to maximize long-term growth.
• Investors nearing retirement: May prefer a greater allocation to Fund C and Fund G to reduce portfolio volatility and protect their accumulated savings.
• Passive management: For those who do not wish to manage allocations actively, NPS offers Auto Choice, which automatically adjusts the asset mix based on the subscriber's age.

Poles apart

INDEX OUTLOOK. Nifty Bank indicates potential to rise while Nifty and Sensex have room to fall

By Gurumurthy K (bl. research bureau)

Nifty 50, Sensex and Nifty Bank index fell in the first half last week. Nifty and Sensex remained stable in the second half and closed about 0.7 per cent down each. Nifty Bank index, on the other hand, bounced back well, recovering all the loss. It closed the week higher by 0.47 per cent.

There is a divergence visible on the chart. Nifty has more room to fall. Sensex is very close to a key support. Nifty Bank index is already holding well above its support and has a good chance to rise from current levels itself. Broadly based on the recent price action, it looks like the Nifty Bank index can outperform in the coming weeks.

FPIS SELL

The foreign portfolio investors’ (FPIs’) selling spree continues. The equity segment saw a net outflow of about $4.5 billion last week. We reiterate that the FPIs have to come back strongly into the domestic market in order to boost the Nifty and Sensex.

NIFTY 50 (23,366.70)

Short-term view: Nifty is struggling to rise past 23,500 decisively. That keeps the bias weak. Nifty can fall to 23,000-22,900. If the index manages to bounce from this region, it can rise again towards 23,400-23,500.

But a failure to bounce back and a break below 22,900 can trigger an extended fall to 22,400. However, a fall beyond 22,400 is less likely now in the absence of any new negative trigger.

Key resistance is at 23,850. Nifty has to surpass this hurdle in order to ease the downside pressure. Only then a rise to 24,300-24,700 will come into the picture.

Medium-term view: As mentioned last week, Nifty is now coming down within its broad 22,000-26,500 range. We expect this range to remain intact. As such, the downside can be limited to 22,000 if the index declines below 22,400.

We retain our bullish bias of getting a breakout above 26,500 in the coming months. That can take the Nifty higher to 28,000 and 30,000 in the long term. The bullish view will go wrong only if the Nifty declines below 22,000.

NIFTY BANK (54,496.25)

Short-term view: The recent price action indicates that the Nifty Bank index is getting good buyers in the 53,000-52,800 region.

Supports are at 53,750 and 52,500. As long as the index stays above 52,500, the bias will remain positive. Nifty Bank index can rise to 56,500-56,700 first and then to 58,500-59,000 eventually in the short term. The index will come under pressure for a fall to 50,500 only if it breaks below 52,500. But that looks less likely.

Medium-term view: The broader picture remains positive. Nifty Bank index can rise to 64,000-65,000 on a break above 60,500 – the intermediate resistance. From a long-term perspective, the index has potential to target 68,000-69,000. The bullish view will remain intact as long as the index stays above 50,000. The index has to decline below this support to indicate a trend reversal.

SENSEX (74,243.34)

Short-term view: The near-term picture is still weak. However, there is limited room to fall from here compared to the Nifty. Support is in the 73,000-72,700 region which can limit the downside.

Sensex can bounce from this support zone and rise back to 74,500 initially. An eventual break above 74,500 will then clear the way for a further rise to 76,000-76,500.

Medium-term view: Crucial support is around 71,500-71,000. We expect the Sensex to sustain above this support and keep the 71,000-86,000 range intact. Sensex can make a bullish breakout of this range eventually. Such a break will clear the way for a rally to 90,000 initially and 94,000 eventually over the long term. Sensex has to decline below 71,000 to turn the outlook bearish and fall to 69,000.

NIFTY MIDCAP 150 (22,251.80)

The index is stuck inside the 21,700-23,000 range over the last seven weeks. A breakout on either side of this range will determine the next move. A break below 21,700 can drag the index down to 21,500-21,400 or even 21,000. A fall beyond 21,000 is less likely.

On the other hand, a break above 23,000 can take the index higher to 23,100, a crucial resistance. The broader picture remains positive. As such, we retain our view of seeing a bullish breakout above 23,100 eventually. Such a break will take the Nifty Midcap 150 higher to 26,000-26,500 and 28,000-28,500 in the long term. This bullish view will go wrong only if the index declines below 20,800.

NIFTY SMALLCAP 250 (17,054.50)

The support at 16,600 held very well as expected. The index has risen back recovering all the loss from the low of 16,683.35. That keeps the overall bullish bias intact.

Short-term support is in the 16,400-16,200 region. The index can rise to 17,500 and even 18,000-18,300 in the coming weeks. We reiterate that 18,300 is a crucial resistance. The bias is positive to breach this hurdle eventually. That in turn will clear the way for the Nifty Smallcap 250 index to rally to 22,500-23,000 and even 24,000 in the long term. From a big picture perspective, the index has to decline below 14,000 to turn bearish, which looks unlikely.

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KEY SUPPORTS

• Nifty 50: 22,900, 22,400
• Sensex: 72,700, 71,500
• Nifty Bank: 53,750, 52,500

Dollar gets a boost

US MARKET OUTLOOK. Equities knocked down on rate hike prospects

By Gurumurthy K (bl. research bureau)

The Dow Jones Industrial Average, S&P 500 and the NASDAQ Composite index witnessed a strong sell-off on Friday. The NASDAQ Composite tumbled over 4 per cent, while the S&P 500 and Dow Jones fell 2.5 per cent and 1.3 per cent respectively on Friday. On the forex front, the dollar index and the Treasury yields got a boost on Friday from the jobs data release. The US added 172,000 jobs to its non-farm payroll in May, which was significantly higher than the market expectation of 80,000. Meanwhile, the unemployment rate remained stable at 4.3 per cent.

These strong job numbers are strengthening the case for a rate hike from the US Federal Reserve this year, which pushed the greenback and yields higher on Friday.

DOW JONES (50,872.08)

The rise to 51,500 happened as expected, but the index has declined sharply from its high of 51,665. Key supports are identified at 50,600 and 50,250. A bounce from either of these supports could take the Dow Jones back toward 51,500 and keep the door open for 52,500. However, 52,500 remains a crucial resistance that could halt the rally and trigger a reversal toward 51,000 or lower. If the index breaks below 50,250 immediately, there is a danger of a further fall to the 49,500-49,200 range, negating the chances of reaching 52,500.

S&P 500 (7,383.73)

Contrary to expectations, the index declined and broke below the support at 7,500. Crucial support is now in the 7,330-7,300 region. The index must sustain above this support and bounce back to reach 7,450-7,500 again. A failure to hold and a break below 7,300 would be bearish, potentially leading to a fall toward 7,150-7,100, which would indicate that a top is in place. Ideally, the index needs to rise past 7,500 to restore its earlier bullishness and make the target of 7,700-7,800 possible.

NASDAQ COMPOSITE (25,709.43)

As cautioned last week, a strong reversal has occurred. While a reversal was expected around 27,500, the index turned down after reaching a high of 27,190. The overall bias is now bearish, with a potential fall to 24,500-24,000. This decline could happen immediately or after a short-lived corrective bounce.

DOLLAR INDEX

The dollar index (100.10) has risen sharply, breaking above the resistance at 99.55, and the outlook remains bullish. The region between 99.55 and 99.45 will now serve as support. A fall below 99.45 would be required to put the index under pressure, but this appears unlikely. In the short term, the dollar index could rise to 100.70-101. From a long-term perspective, 101-101.30 is a very crucial resistance zone; a sustained rise above 101.30 could see the index rallying to 105 this year.

TREASURY YIELD

The 10Yr Treasury Yield (4.53 per cent) has recovered well from last week's low of 4.42 per cent. The important resistance to watch is 4.6 per cent. A decisive break above this level could take the 10Yr Yield higher to 4.8 per cent in the coming weeks.

SpaceX inks three-year $30-billion computing power deal with Google

Alphabet Inc’s Google has agreed to pay Elon Musk’s SpaceX $920 million a month for computing power as part of a cloud services deal that runs through mid-2029, its second such agreement with an AI competitor in a matter of weeks.

Google will pay SpaceX the monthly fee from October this year through June 2029, SpaceX said in the filing Friday. That amounts to about $30 billion through the time of the agreement.

If SpaceX fails to deliver access to Nvidia Corp chips as part of the deal by September 30, Google has the right to terminate the contract, with a one-month grace period, the filing shows. A Google Cloud spokesperson said the deal would help the company meet demand for its AI services. In its most recent earnings report, Alphabet said Google Cloud’s backlog — the measure of contracted work that hasn’t been recorded as revenue yet — nearly doubled from the prior quarter to more than $460 billion.

‘BRIDGE CAPACITY’

“This is a short-term, timely agreement to ensure we have bridge capacity to meet surging customer demand for our agent platform, Gemini Enterprise, which has been even higher than we expected,” the Google Cloud spokesperson said. The agreement involves AI chips, memory chips and other related components. Based on the capacity of Nvidia’s H200 chips, that may represent well over 100 megawatts of computing power — or enough power to energise 75,000 homes at any given moment.

The cloud deal isn’t the only pact that Google and SpaceX have been engaged in talks over. The two companies had been discussing launching the search company’s test products for orbital data centres, a person familiar with the matter said in May.

Under the pact disclosed on Friday, either party also has the right to terminate the arrangement with 90 days’ notice — the same feature as in Anthropic’s deal.

Bloomberg

AI will reshape jobs, but India’s big challenge is preparing workers, boards and classrooms

The Hindu Huddle. Redesigning education, skilling and research for an AI-led future is more critical than the debate over potential job losses, say industry veterans

By Jyoti Banthia and Siddhi Patil

The debate around Artificial Intelligence has largely been framed around a single question: Will it take away jobs? But at The Hindu Huddle’s session on “I, Robot: How AI is reshaping the future of work”, industry veterans argued that India risks missing a far more important conversation — how to redesign education, skilling, research and businesses for an AI-led future.

The panel, moderated by businessline editor Raghuvir Srinivasan, brought together former Cognizant CEO Lakshmi Narayanan, former Nasscom president and NITI Aayog distinguished fellow Debjani Ghosh, and B Santhanam, former CEO - Asia Pacific and India Region & Chairman, Saint-Gobain India.

ONLY A CORRECTION

Ghosh argued that the narrative around AI-driven job losses is often misplaced. “A lot of the displacements till now were due to over-hiring during the pandemic. So it was correction that was happening,” she said, pushing back against the view that AI is already eliminating large numbers of jobs.

That does not mean the risks are insignificant. As AI systems become capable of performing routine and repetitive tasks, entry-level jobs are likely to come under the greatest pressure. “The entry-level will definitely get disrupted. And that is important because that’s millions of people in India and millions of youngsters in India,” Ghosh said.

The challenge, she argued, is to figure out which parts of a job can be automated and which continue to require human judgement. That future, she said, will be defined by what she called the “human sandwich model”. “You need the humans to frame the questions and inputs, AI does the work, and then you need humans again at the end to verify the outcome,” she said, adding that the model will become even more critical as autonomous AI agents become commonplace.

THE GLOBAL AI ECONOMY

The conversation soon moved beyond jobs to India’s place in the global AI economy. While India has emerged as one of the world’s largest digital markets, Ghosh warned that being a consumer of technology is not the same as being a creator of it. “The AI economy is being dominated by two countries, the US and China. For India, we should at least aspire to get 10 per cent of that,” she said.

B Santhanam argued that India can create disproportionate impact through the diffusion of AI across sectors such as agriculture and education. However, he pointed to a critical gap: the lack of technological literacy in corporate India. “In the Nifty 45, there are 230 independent directors. Less than 10 per cent of them have any understanding or knowledge of technology. That’s the state of our boards,” he said.

This lack of engagement at the board level is particularly concerning as technology transforms industries. “Not one company in the managing director’s report had AI mentioned. Not one. That’s shocking,” Santhanam noted.

WEAK LINKS

Lakshmi Narayanan echoed concerns about India’s preparedness, particularly in education and research. Asked whether Indian colleges are producing graduates ready for the AI era, his answer was a cautious "no." He emphasized that India needs to move beyond being comfortable with diffusion to building stronger capabilities in innovation and research that drive technological leadership.

“We are not investing enough in research. The blame goes to the private sector,” Narayanan said. He argued that India needs these stronger capabilities if it hopes to play a meaningful role in shaping the next wave of AI.

Taken together, the panellists painted a picture that was neither utopian nor alarmist. AI will disrupt jobs, particularly at the bottom of the pyramid, but it will also create new opportunities. Whether India emerges as a creator of value or merely a consumer of it will depend on how quickly it can overhaul its classrooms, boardrooms, and research labs.

Monsoon advances up west coast even as signs of El Nino strengthen

WET SPELL. Met Department says conditions favourable for the rains to cover much of the country in 2-3 days

By Vinson Kurian, Thiruvananthapuram

The monsoon advanced further along the west coast and into the interior peninsula on Saturday, covering the whole of Goa and extending across parts of Karnataka, Maharashtra and Andhra Pradesh, while spreading over most of Tamil Nadu and into Mizoram and Manipur in the North-East.

The India Meteorological Department (IMD) said the monsoon’s northern limit passed through Devgad in Maharashtra; Koppal in Karnataka; Anantapuramu in Andhra Pradesh; Chennai; and Aizawl on Saturday afternoon. Conditions remain favourable for the monsoon to advance further into Maharashtra, Karnataka, Andhra Pradesh, and Telangana, the remaining areas of Tamil Nadu, and the rest of the north-eastern States over the next two-three days.

Satellite imagery on Saturday evening showed extensive rain-bearing cloud bands over parts of Karnataka including Hubballi, Belagavi, and Kalaburagi; Kolhapur and Ratnagiri in Maharashtra; Hyderabad, Kakinada, Visakhapatnam and Komarada in Andhra Pradesh; Kalimela and large parts of Odisha; Jagdalpur in Chhattisgarh as well as large parts of West Bengal and the southern parts of north-eastern States.

The IMD indicated that a fresh western disturbance expected around June 11 could dip south into the north-east Arabian Sea off the Konkan-Mumbai coast and emerge with a cyclonic circulation. The system may trigger thunderstorms over Mumbai and adjoining south Gujarat for several days.

EL NINO LOOMS

At the same time, global climate indicators point to a strengthening likelihood of El Nino conditions in the tropical Pacific. Sea-surface temperatures have crossed the critical 0.5°C threshold commonly associated with the onset of El Nino. International agencies estimate an 80-90 per cent chance of the phenomenon developing through June and July and potentially peaking between November and January.

OCEANIC PATTERNS

The equatorial Pacific has transitioned rapidly from neutral conditions towards a clear El Nino pattern. While oceanic signals have strengthened, atmospheric responses typically lag and may take more time to fully develop. Even so, evolving El Nino conditions can begin influencing global weather patterns, including the monsoon.

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RAIN IMMINENT. Intense clouds cover Maharashtra, Telangana, Andhra Pradesh, Odisha and West Bengal as the monsoon extended across these States on Saturday.