In an exclusive interview to CNBC-TV18's Latha Venkatesh, Nouriel Roubini, Professor of Economics, NYU Stern School of Business spoke about his outlook on global growth.
In an exclusive interview to CNBC-TV18's Latha Venkatesh, Nouriel Roubini, Professor of Economics, NYU Stern School of Business spoke about his outlook on global growth.
Below is the verbatim transcript of the interview.
Q: For starters, I wanted to ask you if there is any risk in the way financial markets are pricing in growth. The US markets had 62 all-time highs in 2017. Is there a risk that the markets are already frothy?
A: Certainly if you are looking at price-earnings ratios (P/E) in the US, they seem to be high. There is one measure that is the cyclical adjusted P/E ratio that my former colleague at Yale, Robert Shiller has arrived and is already two standard deviations above the historical mean. This is a sign that either a significant correction can occur over time or if a correction were not to occur that over the next 10 years, equity returns are going to be relatively low since some of the increase in valuations have been stealing some of the gains from the future. But is also true that while these valuations are high, a couple of caveats. A correction might occur only somewhere down the line. It might take a year or two or three. The fact that these measures are above historical average does not mean the correction occurs.
Secondly, usually corrections occur only if there is a macro shock that leads to then a risk-off episode. In the last two years, as I pointed out, was China worries, US growth stalling worries, Fed worries, all falling and collapsing worries. None of these risks so far seems to be high, but we need a major macro risk to have a correction. Secondly, to have not just a correction of 10 percent, but a bear market, you need something like a stall of economic growth and currently, the risk of US recession is low.
So 10 percent is unlikely, 20 percent is even less likely. But it is also true that increasingly there has been a gap between Wall Street and Main Street. Wall Street prices have gone higher and higher while US economic growth has been stalling around 2 percent, real wages have been growing in a mediocre way. Many people and households have still a lot of debt and their income growth is mediocre. So, Wall Street has gone this way, Main Street has been going this way, so either eventually there is a pickup of growth that justifies this high valuations or eventually this gap between Wall Street and Main Street is going to lead, at some point, down the line to something of a market correction. When that correction is going to occur is not clear, but something has to give in over time.
Q: Would it be the tax cuts? You have tweeted and written about the tax cuts that they are fundamentally inequality exacerbating, that they are a favour for the rich. Would you say that that could risk, a year down the line, some kind of popular resentment and therefore, a political economy risk?
A: In the short-run this tax cut that go mostly to the corporate sector, the corporate tax rate cut from 35 to 20 percent and mostly to high net worth individuals have been boosting the stock market further higher and has gone to even higher levels. You are asking the question of whether eventually this rise in income and wealth inequality may lead to a political backlash and resentment that is going to lead them to more populist policies like protectionism, migration and other ways of micro managing the political system, that the private sector, that it will be negative economic growth and for the stock market. That is a risk over the medium term.
In the short-run of course, these tax cuts will boost further the business and investors' confidence. But that one lesson we have learned is that this populist backlash against globalisation, trade migration is in part driven by this rise in inequality and this rise in inequality is driven by globalisation, trade migration and technological innovations that tend to be skill buyers, labour saving and so on and therefore, that is a risk that we have to address. If we do not address it, eventually, those who are left behind are going to vote in a way that will be damaging of economic growth and of the stock market.
Q: But more near-term, we are seeing a fairly rapid slide in the dollar. If the US corporate sector is so healthy and the tax cuts are going to make it even richer, how do you explain this dollar slide over the last 2-3 weeks? It has been particularly surprising.
A: It has not just been in the last 2-3 weeks but if you are looking from the beginning of the Trump administration after the initial blip upwards, there has been something of a weakness of the US dollar. Now the value of the dollar depends on relative growth rate or relative monetary policies and what has happened has been that the Fed has been hiking, but it has been hiking very gradually. While right now there is a signal that some of the other central banks that they were involved into unconventional monetary policy may gradually phase them out. The European Central Bank (ECB) has cut their purchases from USD 60 billion per month to USD 30 billion. They may end up this plan of quantitative easing in September. They might start hiking right after that. So what matters is the policy part of the Fed has already been priced in. while there have been now surprises on the upside in Europe, in Japan and other advanced economies suggest a different part of monetary policy.
Secondly, growth has picked up in the US but this growth has picked up even faster in Europe and some of the advanced economies and emerging markets and since valuations in the US are high, since P/E ratios have been high, while they have been, for the last few days depressed in Japan, in Europe and in emerging markets, money is now moving slightly out of the US market and goes in Europe, Japan and emerging markets and that leads not only to equity rally, but also some appreciation of these currencies like in the case of India, where the foreign direct investment (FDI) and the foreign portfolio investment (FPI) strengthened the currency but also strengthened the stock market. And I would say the final reason why the dollar has been weak is that until recently, the market believed that the Fed was wrong, that these forces have led to low inflation are not transit but are permanent.
Technology, globalisation, trade, weak labour, weak union, all these innovations make goods and services cheap. The phenomenon of Amazon crowding out and competing against other retailers. So if these forces lead to low inflation are global and they are permanent, the view that the Fed is going to hike three times this year, let alone four, may be farfetched. The Fed might hike only once or twice. If inflation keeps on surprising on the downside, the market did not believe the Fed and they believe the Fed is going to do less than what the market is predicting, that has been also a source of potential dollar weakness.
Q: But is there a vulnerability there? Do you think that sometime in the first half of 2018 itself, we could see some smart rise in the dollar? Is that a possibility?
A: It is certainly a possibility. The question is how much US growth is going to pick up relative to other advanced economies, how much the Fed might surprise on the upside, inflation surprises on the upside, by hiking not only two times, not only three, but even more. As I said, the value of the dollar depends on not just what monetary policy, growth and inflation are in the US, but also what monetary policy, growth and inflation are in Europe, in Japan and other major emerging markets. In the case of many emerging markets, actually their currency appreciation may be affected also by the foreign exchange intervention policy of the central bank.
The RBI actually reacted there this past year to the strengthening of the Indian rupee by intervening quite aggressively. The amount of reserves has been significantly increased. There has been even forward intervention and the appreciation of the rupee, given the capital inflows would have been even stronger if that intervention had not occurred. So another valuable to keep in mind is how much central bank is going to do verbal intervention initially and actual forex intervention as a way of limiting or reversing some of those appreciation pressures. Central banks in emerging markets do intervene, the Fed does not intervene in forex markets.
Q: You alluded to the recovery, global synchronised recovery in all countries or many major economies. Do you think now we are stepping into a new normal? There was this new normal from 2008 to 2017 where we thought we will never get to 3 percent or 3.5 percent global growth. Do you think we are starting a new normal where we could be in the 3.5-4 percent growth globally for a longish period?
A: That, in my view, is an open question because the conventional wisdom of International Monetary Fund (IMF), Organisation for Economic Co-operation and Development (OECD), in most economies have been that potential growth, both in advanced economies and emerging market has fallen in the last few years, has fallen because of the legacy of the global financial crisis, high debts and the need to deleveraging because capital expenditure (Capex) spending has been low and therefore a lot of productivity growth is embedded in new capex, productivity growth has been mediocre.
Demographic changes like aging, not in India, but a significant aging of population in advanced economies, US, Europe, Japan, but also in some major emerging markets like China, like Russia, like Korea and so on, all these are factors that imply that potential growth has been lower and that is why the IMF was talking about the new mediocre. Today, there is a global expansion. Growth is accelerating. In some countries going above potential and as long as there is slack in goods and labour market, growth can be above potential for a while even if potential is low without causing inflation.
So some of this recovery may be just cyclical and whether it is going to increase also potential growth is open to question. Some people say if it becomes persistent, there is a significant increase in capital spending then productivity growth can increase, that is going to increase potential, other people are more sceptical about that. We do not know yet the answer. Another important thing has to happen is that this good moment for the global economy should be a period, not of complacency but countries should be doing the kind of economic reform and structural reform that increased potential growth.
We need structural reform in Europe and Japan, but we need them in US, we need them in China, we need them in India, we need them in Russia, in Brazil and most emerging markets. But we know that the political economy or structural reform is that they occur always more slowly than desired and optimal and therefore, I think that is a necessary condition for having a pickup not just significantly of growth, but also of potential growth. So the jury is out on whether this is just purely a temporary cyclical recovery or the beginning of a more positive trend for the global economy.
Q: Is there a threat or a possibility, what are the bets, of crude being USD 80 per barrel in 2018? Are the bets very high?
A: Oil prices have been rising in the last few months, in part because there is stronger global economic growth and therefore, there is higher demand, in part because there have been some negative surprise shocks like supply disruptions in places like Venezuela, Nigeria, Libya and you name it. In part, there is also a threat of a bigger supply shock that may come if this conflict between Iran and Saudi Arabia, right now is a proxy way fought in other lands in Middle East could become a hot war between them.
And of course, Organization of the Petroleum Exporting Countries (OPEC) has been also somewhat successful thanks to an agreement between Saudi Arabia and Russia to try to limit the supply and the production. But the big game changer today, as we all know, is that there is shale gas and oil in the US and is not part of OPEC and the supply response of shale gas and oil to a rise in price is very fast. If you are a traditional oil producer, you need, with higher oil prices, 5-6 years before you can dig oil from the ground. You have to spend billions of dollars, do exploration, drill a hole, bring the equipment until eventually, you pump oil, but a cycle with shale is six months.
As soon as prices go higher, they put more rigs in the ground, they pump the oil and gas, and therefore that increase in supply puts a limit on how much oil and gas prices can rise. So I would say already with oil at USD 70 per barrel, I expect there will be a significant delay, but in six months, supply response from shale gas and oil is going to reduce oil prices. If prices were, because of some temporary factor, to go to USD 80 then supply response is going to be even stronger. So the fundamentals of demand and supply barring major geopolitical shock suggests that oil equilibrium today is more in the USD 60-70 range. I do not expect it to be USD 50, I do not expect it to be however, USD 80 per barrel. A shock can lead it to USD 80, but that should be temporary.
Q: Let me get a couple of your opinions on some Indian questions. We are on the eve of a major Indian Budget. Budgets are very big events in India because there are policy announcements by the government. Now, one of the normal debates is that should the government increase the fiscal deficit and invest so that it can give growth a leg up. Would that be your advice?
A: My advice will be that first of all, the Budget deficit of India is still large, at the central level, but also you have fiscal problems at the state and local level and therefore, fiscal prudence is necessary. And the risk is that even if you wanted to do a fiscal stimulus as a way of boosting economic activity, what you have observed in the last few months has been the long-term interest rates in India have gone higher and have gone higher, not just because of global factors, but more importantly, because there was a concern that the fiscal deficit is too high and even with RBI marginally cutting policy rates, the impact on long-term interest rate has been just to slow down the rise of this long-term interest rates.
And therefore, any positive impact on economic growth coming from a meaningful fiscal stimulus is going to be undone by a potential rise in long-term interest rates. It is going to crowd out that recovery. Of course, the country is facing fiscal challenges also because when oil prices were falling, that reduction in oil prices were not transferred to the retail level and it led to greater revenues for the government that were spent, rather than saved in the good times.
And now that oil prices are going higher, either you increase oil prices to maintain the same revenues, but if you do that, politically a year before election, that is not something that is going to be appealing and therefore, the revenue is going to shrink and the Budget deficit is going to be rising. That requires fiscal prudence because otherwise, you have increase in long rates. Probably the way to square this cycle is that you do not want to cut spending, and revenues are falling and you do want to have a larger Budget deficit will be more divestments of state-owned enterprises and selling to market and partially privatising some of those assets, that will be good for the economy and in my view, a loosening up of the Budget constraint that the government is facing.
Q: The other debate that is constantly in India is the fate of our public sector banks. Up until recently, about 75 percent of the banking system was dominated by public sector banks. Now of course, because of partly government policy and partly economic growth, not coming good, we have seen them with a large number of bad loans, default loans. What would be your advice to the government of India? Privatise what is a good proportion of the banking system that may be with the public sector?
A: The first observation is of course, part of the weakness in private, but even in public investment in infrastructure has been driven by the fact that you have a double problem. One, the banks having a large amount of non-performing assets (NPA) and loans, specially private sector banks and then some parts of the corporate sector leaded with too much debt that they could not pay and therefore, that was a situation that froze the ability to produce and invest.
A good news has occurred, as you know, is this passage of anew bankruptcy law that is going to allow essentially to clean up the balance sheet of the corporate sector to sell some of the assets to other investors, domestic or foreign and then put them at work. Second then, you have to do on the other side is you also have to recapitalise these banks to make sure that they can lend again, that process is occurring. So that, over time, over the next 12 months is going to lead them to some positive creation of credit growth and ability to do more investment. But the reality is that there is no real strong fundamental reason for the public sector playing a significant role in bank intermediation.
If you do not want to fully privatise these banks, you could reduce your share from a controlling one to a maybe strategic minority share to essentially partially privatise these banks and give them operational and financial independence so they can pursue maximisation of returns, even if they are publically owned in part, they are subject to Budget constraints and incentives like a private firm. So, full privatisation maybe it is unlikely, but partial privatisation and having this independence to pursue what is right should be the right thing to do and maybe there is a possibility that India is going to go in that direction and it will certainly be positive to make sure that the problems of the past, of connected lending and access over credit and pulling out the stalls from the credit allocations and things are not repeated again as you clean up the balance sheets of the corporate sector and of the banking system as well.
Q: So one advice to Prime Minister Modi?A: The advice will be that he has started the process of a variety of economic reforms. More need to be done and the more those reforms occur, the more chances are that potential growth of India goes from 7 percent to 7.5 percent, from 7.5 percent towards 8 percent. But to get to 7.5-8 percent, current policies probably are not sufficient, but more needs to be done. And if he wants to pass to history with a legacy of having changed for the better India, definitely he should be continuing with the same policies in the near future and so on.