Despite the past success, the global economy remains sharply divided into two distinct zones. The developed economies of Europe and Japan are struggling to come out of economic stagnation.
Dr Satyendra S Nayak
Is the global economy on a precipice of another crisis? The question is haunting economist, policy makers, politicians, marketmen, businesses, and investors world over. Having overcome the biggest economic disaster since the Great Depression of 1930s, the global economy now eight years after the crisis of 2008 is still fumbling to find firm grip for sustainable growth trajectory. In coping with the crisis the policy makers adopted the unconventional measure shaking the traditional economic theory. Zero interest rates, quantitative expansion and unprecedented level of deficit financing to pump prime the economies through heightened government expenditure, all yielded results in thwarting the prolonged slump in the global economy and bring it on the path of growth.
Developed Vs Emerging Worlds
Despite the past success, the global economy remains sharply divided into two distinct zones. The developed economies of Europe and Japan are struggling to come out of economic stagnation. Barring the US, Germany, and UK, the developed economic bloc is showing no signs of growth. The major central banks in Europe including European Central Bank, Danish National Bank, Swedish Riksbank and Swiss National Bank have pushed the short term interest rates into negative territory. The yields on short term sovereign bonds of Austria and Netherland have also gone below zero level. Bank of Japan too has bowed to bring interest rates in negative territory and continued with the fresh dose of monetary pumping of economies to promote credit growth. While the central bankers are using all the tools in their armory, the demand for credit is yet to pick up before the credit cycle gathers higher momentum. You can bring horse to water, but you cannot make him drink it. The borrowers in the developed world are still not ready to taste the cheapest credit available in history. The thirst for credit emanating from higher consumption and investment spending seems absent in the wake of stagnant disposable income and low business expectations. Excess capacities and low demand have dampened the animal spirits amongst business investors.
On the other extreme is the emerging economic bloc led by BRICS (Brazil, Russia, India, China, South Africa) that are still showing growth. Top two among BRICS, India and China though recording lower growth still are in high growth trajectory, with China recording 6.9 percent compared to 7.3 percent in the earlier year and India at 7.3 percent. The emerging markets, however, staged lower 4 percent growth compared to 4.6 percent in 2014. Negative growth in Russia and Brazil and slowdown in China brought down growth rate, but emerging markets are still the driving force in the global economy.
Global Growth Slides
The global economy grew lower at 3.1 percent in 2015 compared to 3.4 percent in 2014. The largest economy, the US recorded 2.5 percent compared to 2.4 percent in the earlier year. The Eurozone clocked 1.5 percent and Japan at 0.6 percent. Despite the negative interest rate phasein Japan and Germany and near zero rate in the US and other economies, and record rise in government spending, the developed economies are unable to show sustained growth. The withdrawal of monetary and fiscal stimulus is fraught with a great risk of economies relapsing back in recession. Are the economies facing the phase of secular economic stagnation? The answer seems to be positively yes for Japan, which is struggling for the last three and half decades to come out of virtual stagnation. Japan grew at 0.5 percent during 1980-2015, a period when China transformed itself from a centrally controlled closed communist economy into export oriented quasi capitalistjuggernaut to become the second largest economic power. Japan couldnot stand the competitive advantage of China and South Korea. Growth of China and South Korea in this period was the loss for Japan.
Japan’s Secular Stagnation
Another export oriented rival of Japan, Germany, did not face the same fate as Japan which had to face the regional competition. Germany is not encountering the same problem, since it does not face any competition in exports from the regional neighbors. It continues to run its export engine to drive its growth, although at a much slower rate than before. Japan’s secular stagnation is compounded by both demographic as well as technological factors. The technological advance in electronics and automobile that fired its economic miracle matured in 1990s. With no further breakthrough emanating from these and other industries to ignite fresh investment cycle, growth rate slumped. Demographically japan is facing declining total population and rising aging population. With this demographic trend and relatively high standard of living among broad spectrum of its population, there is very little potential to boost consumption to alevel where it can replace exports to keep overall demand for its products growing. Despite the zero interest rates, the consumption is not growing at a higher speed since the economy is structurally facing a low marginal consumption propensity. Unlike China, Japan is unable diversify its economy from exports to consumption. The government spending was the only policy option open to prevent the economy from going into deep recession. During the last few years expansion of bullet train transportation was indeed an area to disperse population over newer and less populated areas and thereby promote growth in housing and other infrastructure areas. Japan’s economic experience over last three decades is a true illustration of what is termed in economic theory as the phase of secular stagnation. Former Treasury Secretary Larry Summers is hinting that the US economy may also slip into the same phase of secular stagnation, and hence is not in favor in interest rate hike now and also did not approve the one done last year.
India – The Rising Star
China’s export led double digit growth story is over. Yet it is remarkable that having catapulted into the second largest economy rivaling the US, China’s growth has not slumped to a very low level. Its current growth rate on a considerably higher GDP base gives much higher incremental GDP than 10 percent earlier on a lower GDP base. Yet, itsrepercussions onlowering global economic growth are obvious. To offset this,Asia’s third largest economy that will soon be also the global third, India, will emerge as the world’s fastest growing economy with the growth rate of 7.5 percent for a decade and more.
It may grow even higher and touch the double digit growth of 10 percent if economic liberalization gathers greater momentum than now. Unlike China India cannot adopt export growth model. It has to work on a growth cluster comprising several sectors. India’s economy is poised to grow higher from diversified group of driving sectors. Growth in domestic consumption will be supported by import substitution (more in defense),exports, services and infrastructure sectors. In India, agriculture is still dominatedby the performance of Monsoon. The overall growth rate gets influenced by the bounty or otherwise of rains. If the current year experiences normal monsoon against the last two years of below normal Monsoon, the agricultural sector will record 6 percent growth this year. The overall growth in that case will touch 9 percent. Even otherwise, there is enough scope for agriculture and farm sector to improve productivity to bring the normal growth trajectory of the economy higher by 1 percent to 1.5 percent. The rate cut by the RBI of 0.25 percent although it dis appointed the stock market was prudent. It is desirable to wait for the first signs of the character of Monsoon this year. Another bad Monsoon would bring pressure on prices of essentials. Further, lower record crude oil price last yearhas been great boon to the economy in lowering costs and inflation rate, and help in lowering balance of payments deficit. Any untoward increase in crude oil price would stoke inflation again and also bring pressure on external deficit affecting the Rupee. If the developments on both these fronts are favorable by the mid year, the stage can be set for next rate cut.
The Fed VsThe Market: Flattening Yield Curve
All eyes are on next Fed move. Going by the favorable figures on employment and inflation, the Fed reversed the falling interest rate regime by raising the Fed funds rate by 0.25 percent after 8 years in December last year. It did have an unsettling effect on rest of the world. The rate rise strengthened the dollar resulting inglobal reallocation of financial assets in favor of the US, and haircut in emerging markets portfolios. Flattening of the yield curve for US Treasuries despite the rate increase gave a clue of the market perception of the financial markets.
The spread between the 3 month and 10 year Treasuries came down from 201 basis points in December to 176 basis points in January and to 146 basis points in February, indicating the market’s perception of less vigorous growth in the economy in coming months. The liquidity in global financial market continues to be such that its effect has blunted the rate rise by the Fed. In this situation the Fed’s open market operations are not having much impact on the market rates. The demand for theUS Treasuries and bondsstill continues to outweighs the supply despite the Fed’s OMOs, thereby offsetting the upward pressure on interest rates. In recognition of this market reaction, and Janet Yellen’s recent admission of looking out into the global economic scenario in addition to domestic twin guideposts of employment and inflation numbers, the Fed may defer its second rate hike until the second half of 2016.
Although the global economy is not on the verge of any mini crisis currently, it is facing a slowdown compared to 2015. Eurozone is yet to capture the higher growth path and Japan is still in firm grips of secular stagnation. The US may clock the same growth as the last year, but is yet to show any sign of gaining higher growth momentum. The current hotspot in global economy is China. Having experienced a sharp slump in its growth rate, the objective would be to keep the long term growth in 7 percent trajectory. The slowdown in real estate sector and its effect on the banking sector needs to be managed to obviate the possible trigger for avalanche in the financial sector. If this is managed and the possible sensitive point for another blow out desensitized, China’s soft landing would contribute to global stability. India, the rising star in Asia and global economy can now tap its growth potential and keep the global economy on a firmer growth path.