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Depressing Numbers

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True, much of this slowdown will be felt in the US; growth prospects for that country have deteriorated more rapidly: Growth estimates for 2009 are 1.2 per cent lower. As US banks and financial institutions continue to take hits to their assets, those already pessimistic projects could go even lower: the WEO points out that if global growth falls below 3 per cent, we will be in a global recession. The probability of that happening is estimated at 25 per cent.

But there is a silver lining. Emerging markets, led mainly by China and India, will boost overall global growth, says the WEO; any slowdown in those economies is likely to be moderate, as they have no exposure to the credit crisis that has gripped the US and Europe.

Alex Patelis, head of international economics at Merrill Lynch, says there is a fallacy in blindly believing that what’s happening in the US will soon be happening everywhere else. “We disagree. Blue, red, yellow, pink. This is a big world, and investors should celebrate its diversity,” he says in a research report for investors.
Just What Happened?
The WEO identifies three major concerns that could impact the global economy more adversely that it has already. Inflation — led largely by higher energy and food prices — is rising all over the world. Second, despite the decreased momentum, commodity markets continue to boom. What is not clear is whether the commodity price boom is a consequence of loose monetary policy in the US and the UK, or a function of high current demand. At least in part, says the IMF, the recent run up in commodity prices could be the result of investors seeing it as an alternative asset class.
Third, the financial shock emanating from the collapse of the housing markets and the subprime mortgage market crisis has inflicted considerable damage to institutions at the core of the financial system. Low liquidity in inter-bank markets and weak capital adequacy in banks has fuelled concerns about credit risk.

As John Maynard Keynes put it, “Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.” Economists in the US are not quite clear whether the US is in a recession or not. Government officials certainly don’t think so. “We expect growth (in the US) will slow to 0.5 per cent in 2008 and 0.6 per cent in 2009,” says Simon Johnson, economic counsellor and director of research at the IMF. “We also expect a gradual recovery toward potential beginning in 2009.”

Emerging Risks in Emerging Markets...
The greatest risks to the global economic outlook come from events in financial markets that are still playing out. Even the titles of research notes being put out by major investment banks are reflective of that sentiment: ‘Fasten Seatbelts’ (Goldman Sachs) ‘The risks of decoupling’ (Merrill Lynch), and so on. In particular, the potential for even deeper losses to US banks could have a severe impact on company balance sheets in other sectors. “Although only a few firms have reported first quarter results, early signs are awful,” says David Kostein, chief investment guru at Goldman Sachs in New York. “We expect a swath of lowered profit guidance.”

So what about emerging markets’ prospects? Amit Bhatiani, portfolio manager at Wall Street hedge fund Duma Capital points out that Asia would not receive special dispensation from a US recession. “There is deep uncertainty regarding the economic and financial outlook,” he says. “The notion that India and China have ‘decoupled’ from the rest of the world is popular. But much of the high-octane growth is export-led and while there's a fair amount of intra-regional trade, the biggest end-market is the US.”
High on the risk table for emerging markets — including India — is high and persistent inflation. The producer price index — or the wholesale price index (WPI) in India shows some cause for alarm. In both China and India, producer prices show double-digit growth. Producer prices — mainly oil and raw material inputs — are rising faster than consumer prices.
To compound matters, an accurate reading of the real level of inflation is hampered by administer pricing mechanisms mainly for fuel and foodstuffs. And complicating the assessment of how much upward pressure there is on prices is the lack of pass-through to consumers, all of which distort price signals.

...And In India Too
Is there a risk that the Indian growth story could be derailed? Warnings about inflation from the Reserve Bank of India (RBI) and a sudden large adjustment in the WPI done in early April highlight the potential risks to our economy. From 9 per cent in 2007-08, projections for 2008-09 are down to 8 per cent.
Agricultural production — and given food price inflation — is a cause for concern. Tightening liquidity conditions, perceived high interest rates, a domestic credit shock and capital outflows together could be the perfect storm that drives growth rates below 6 per cent.

“But the probability of such a ‘perfect storm’ occurring is very low,” says Kalpana Kochhar, senior adviser at the Asia Pacific department of the IMF. Finance Minister P. Chidambaram doesn’t think that such a big drop in growth rate is likely either, even as he acknowledges that a slowdown may be necessary to bring down inflation, particularly food price inflation which can be critical in this election season.
We are reasonably self-sufficient in major commodities, and the food supply is more or less in balance. But food prices and commodity are likely to remain high, driven by growing incomes; but how much of that inflation is permanent and how much temporary is to be seen.
Monetary policy cannot address inflationary pressures that are supply-side driven. The more classic response would be to let the exchange rate appreciate, but that too is a political no-no in the current circumstances.
So while India may be relatively insulated from the contagion of the credit market, this is no time for complacency either. As IMF’s Johnson says, now is the time when prudent governments should draw up contingent plans to guard against deeper ‘tail risks’ — the risk that an unlikely event that can create catastrophic results. Buried in the IMF’s cautious optimism lies the scintilla of doubt.
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(Businessworld issue 29 April-5 May 2008)

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