A GREAT RECESSION, NOT A GREAT DEPRESSION
Chief economist at Standard Chartered
July 13 - 19, 2009
The scale of international fiscal and monetary policy easing - and the prospect of more to come - is having an impact by minimising the downside for the global economy. The question is when it will allow economies to turn the corner and recover.
Even though the scale of the stimulus is huge, it is fighting to offset strong downward pressures. There are three combined deflationary forces: (1) the balance-sheet restructuring across the corporate and household sectors and the deleveraging within the financial sectors in many countries, particularly in the West; (2) the severe inventory reduction underway as demand weakens; and (3) the collapse in world trade.
The downside pressures are still winning, but the rate of decline is easing. And previous policy measures may finally be feeding through.
Across the globe, the fourth quarter of last year was terrible, even allowing for significant differences across countries. The first quarter of this year was still bad, but perhaps not as bad as the preceding quarter. And in recent weeks, the improvement in financial markets suggests that there is some light at the end of the tunnel.
But be warned. There can be many false dawns in a financial crisis. Furthermore, even though there may have been some recent improvement, the overall situation is that activity is still contracting.
The imbalanced nature of the world economy had many facets, including savings flowing 'uphill' from emerging regions, particularly East Asia and the Middle East, to the advanced economies in the West. Also, the strong growth seen across the emerging world, particularly China, continued to push oil and commodity prices higher, and speculative pressures last year saw oil surge way above USD 100 per barrel.
At that time, we felt that such oil prices were deflationary, not inflationary, for the US and the UK given the state of those economies, and that the downside risk to global growth was the worry, not inflation. This proved to be true. Now, oil prices are substantially lower. We should not overlook the positive impact this may have on global growth, easing some of the pain of adjustment in the West and in other oil-consuming regions such as South Asia and parts of Africa.
The collapse in oil prices may provide a boost of two per cent to global GDP, and this, like monetary and fiscal easing, will take time to feed through.
Moreover, this time a year ago, we stressed a number of features regarding emerging economies: (1) the markets were underestimating the pace and scale of change on the ground in economies such as India, China, and Indonesia; (2) the markets were underestimating the catch-up potential of many of these economies; and (3) just as crucially, the business cycle still existed, even in economies such as China, and we felt that the markets were underestimating the likely volatility of these economies.
The trend may be up, but there will be volatility along the upward path. And so it has proved. Indeed, one of the challenges in emerging economies is that it is only in times of stress that one can test the credibility of policy institutions and tools. Moreover, we felt that while emerging markets were not decoupled, on account of their high reserves, many of them ñ particularly in Asia and the Middle East - were better able to cope.
WHAT, THEN, SHOULD WE BE EXPECTING NOW?
• We see the current crisis as a structural problem in the West, whereas in the East we believe this is a cyclical downturn.
• In the West, we expect economies to hit bottom towards the end of 2009. Despite this, unemployment will likely continue to rise, peaking towards the end of 2010. Unemployment could reach much higher levels in the US than is currently expected. Thus, next year in the US and the UK may well still feel like a recession, given the fear of job losses. The Euro zone, meanwhile, faces severe challenges, both from problems within some of its own economies and from the negative spillover effects of problems in Central and Eastern Europe.
• The recovery in the West will be weak. We do not think markets are taking this fully on board yet. It takes considerable time for balance-sheet restructuring to take place. The US recession began at the end of 2007, and the US could take a full six years to return to trend growth. We expect a policy-induced rebound in the US next year, and this will boost financial confidence, but the pace of the rebound may not be sustained.
• It is important not to be complacent. Sovereign defaults are a major concern, particularly given the problems in Central and Eastern Europe. Although the additional resources given by the G20 to the IMF should help, this will reduce but not remove this risk. Across emerging economies, one needs to be wary of the second-round effects and possible contagion from the crisis in Europe. There may be a retrenchment of international bank lending.
• We expect both East Asia and the Middle East to continue to run current account surpluses. Furthermore, any rebound in activity in the emerging world, say driven by Asia, is likely to result in higher commodity prices. The same factors that led to higher commodity prices last summer could materialise again in any recovery, albeit on a lesser scale. The lack of investment in energy supply has not been helped by this crisis, and once excess slack has been taken up by a recovery, commodity price inflation could return as a risk. We see oil prices above USD 70 per barrel by the end of this year.
• Even though African economies do not have strong financial linkages with the rest of the world, the region has been impacted by the global credit crunch. A combination of factors threaten to keep growth weak, including lower commodity prices, a tougher environment in which to attract funds, a withdrawal of portfolio investment, a shortage of dollars in some markets, and, now, heightened concerns about exchange rate depreciation that have led to a pullback in cross-border lending. South Africa might be able to compensate for the external deterioration through a domestic fiscal stimulus, but in other Sub-Saharan countries, domestic demand may still not be big enough to compensate. Growth will slow.
• In Asia, we think the recession will be shorter and shallower than in the West. But even allowing for this, the region's export-orientated economies will be in recession, with a particularly severe downturn in Singapore, a sizeable one in Hong Kong, and contractions in Malaysia, Thailand and Taiwan, and weakness in Vietnam. In contrast, domestically driven economies such as China, Indonesia and India, whilst slowing, will be better insulated. We continue to expect China to lead East Asia out of recession as its policy stimulus takes effect, boosting rural spending, social welfare, infrastructure spending, low-cost housing, energy conservation, and environmental protection. We expect 6.8 per cent growth in China this year, which will feel like a recession in some regions of the country where unemployment is rising. We also expect further stimulus measures to boost activity next year. With almost two-thirds of Asian exports destined for the advanced economies, and given the scale of the structural problems in the West, any rebound in Asia and other emerging regions will not match the pace of activity seen in the recent boom years.
• There is still a need for Asia to make the switch from export-led to domestically driven growth. This will take time. Also it will require deeper and broader capital markets across the region. Whilst we are not underestimating the cyclical risks, Asia's upside potential should also not be underestimated. If the US recovers first, this will benefit Asia, both directly through its exports and indirectly though equity markets and confidence.
There needs to be an economic recovery for any rebound in equities to be sustained, and the recent bounce in many equity markets may thus be premature. But even if the US does not rebound strongly, as we suspect, Asia does not suffer from the debt and deleveraging problems overhanging the West. Thus, it will have the scope to map out its own recovery. In either situation, there is a need for Asia to boost domestic demand. The region still has plenty of room for policy stimulus now, but it requires a shift in its growth model to see increased private demand in the future.
The OECD calculates that the world economy will contract by 2.7 per cent and that world trade will collapse by 13.2 per cent this year. These are huge declines. In 2006, before the onset of the crisis, the world economy grew by 4.3 per cent and trade by 9.5 per cent.
The West faces huge challenges, and Central and Eastern Europe have big problems, but the Middle East and large parts of Asia look better placed to come out of this sooner, and stronger, with China's rebound playing a key role. China's proactive policy approach is to be applauded.
In fact, the scale of the policy stimulus around the world is huge, although more is likely to be needed. One of the lessons of the Bretton Woods agreement of 1944 was that it did not place enough obligations on the countries that were savers to do more, instead placing the emphasis on debtor nations. This lesson needs to be heeded now. The nations that have the savings, notably in Asia, are those that need to do even more, both now and in the future.