“The good news is that we may be at the end of a free fall. The rate of economic decline has slowed. The bottom may be near – perhaps by the end of the year. But that does not mean that the global economy is set for a robust recovery any time soon. Hitting bottom is no reason to abandon the strong measures that have been taken to revive the global economy”.-Joseph Stiglitz (in “Stimulate or Die” dated 8 Dec 2009)
Economics defines business cycles as economy-wide fluctuations in production or economic activity over several months or years. It includes periods of rapid growth and those of relative stagnation as well. The world economy is on a revival path from the huge contraction that it suffered due to the subprime crisis. As the credit crunch gripped the entire financial system, the central banks moved in unison to avert further deepening of the recession by injecting liquidity into the system. These stimulus packages have provided crutches to the crippled world economy. But these crutches come with a caveat , the longer that you hold on to these crutches the more you get used to them and the lesser become your chances of standing up on your own. This analogy applies to the stimulus packages as well. The government needs to return to a path of fiscal consolidation to avert dire circumstances like hyperinflation which have the potential to ruin a perfectly healthy economy.
Stimulus Packages across nations
The size of stimulus has varied significantly across nations. Including the measures undertaken in 2008, the U.S. stimulus is largest (a cumulative 4.8 percent of GDP during 2008–10), while Italy and India are at the lower end of the spectrum. Two sets of factors help explain the relative size of stimulus packages: (i) differences across countries in the need for stimulus; and (ii) differences in fiscal space. Source: IMF database & 2010 forecast
Countries in which the automatic stabilizers are larger need smaller discretionary stimulus. Government size is a proxy for the impact of automatic stabilizers and is smaller in China, India, the U.S., Canada, and Japan, and it is negatively related to the fiscal stimulus.
Growth impacts and needs
Stimulus efforts, together with the impact of the automatic stabilizers, provide an important boost to growth and help forestall a negative downward spiral. According to IMF Preliminary staff estimate, fiscal policy may have contributed 2–2½ % points to PPP-weighted growth of the nine countries in 2008 and may provide 2–2¼ % points in 2009 and ¼–½ % points in 2010.The decreasing impact of fiscal stimulus is indication for the rollback of stimulus worldwide.
A rollback of stimulus is necessary to bring the economy back to its natural growth path. This artificial growth is not sustainable in the long run and needs to be dealt with on priority. The global markets are upbeat on the magical carpet of the stimulus packages, but the real test for these economies would be when they would be left all alone ,high and dry, in mid air. The action plan should now involve a gradual and judicious withdrawal of the stimulus package as any sort of misconceived notion of a V shaped recovery will be disastrous to say the least. The central banks need to work on their strategies to maneuver themselves on this tight rope with the help of an effective monetary policy.
Risk Analysis
The systemic risks have been substantially reduced following unprecedented policy actions and nascent signs of improvement in the economy. Even with the momentum significant risks remain. These are as follows:
• The recovery is driven largely by government spending in many economies
• Commodity and asset prices have risen aided by high levels of global liquidity
• Emerging market economies which are generally recovering faster than advanced economies, are likely to face increased inflationary pressures
• Uncertainty about the pace and shape of the global recovery
• The surge in oil prices, if global recovery is stronger than expected
• Sharp increase in capital flows, above the absorptive capacity of the economy, which may complicate exchange rate and monetary management
• Large fiscal deficits command a bigger risk to both short-term and to medium-term economic prospects
Global Scenario
Last five year the world has seen a dramatic downside in term of negative growth in their domestic products. All the major economies except China and India have undergone contraction varying from -2.5% (France) to -10.2 % (Brazil) during 2009, as evident from the chart.
The IMF says that, led by China, the world economy is bouncing back strongly from its 2009 decline. US growth is projected to reach 2.7% this year, a nice rebound from last year's 2.5% decline. The IMF, in its latest financial stability report, says there is an urgent need for more regulation of financial institutions.
This entire fiscal stimulus comes at the price of greatly expanded debt. The Congressional Budget Office this week said the US deficit will for the second straight year exceed $1 trillion, an amount equal to about 10% of GDP. This explosive volume of debt will at some point have to be halted and rolled back. But, says the IMF, not yet. The exit from stimulus towards fiscal balance should come only when there is a tangible pickup in consumption, investment and exports. Unfortunately none of these elements are yet present.
Indian Scenario
The economy is steadily gaining momentum, though public expenditure continues to play a dominant role, and performance across sectors is uneven, suggesting that recovery is yet to become sufficiently broad-based. The baseline projection for GDP growth for 2009-10 is now raised to 7.5 per cent.
The Industrial Growth in India has been significant with 7.6% growth rate up to 3rd Q and 11.7% in November but the closest indicator of Industrial growth, bank credit has not exhibited a parallel picture. Growth in Bank credit is sluggish at 8.8% for the first 3 Q of year as against 12.5% last year. This can be due to either low demand of funds from industry or the banks are not lending easily.
Industrial Growth has been high at 6.3% but according to a recent study of 1752 manufacturing firms, done by RBI, financial performance of these firms has declined by -1.6% while net profit were up by 9.6%.This happened mainly due to sharp cut of 9.3 % in raw material cost. The import of capital goods and raw material usually increases during industrial growth but this is yet not visible and it has been negative for November. The fourth indicator of state of industry is the movement in price. Growths of manufacturing industry prices are still low at 5%.
Conclusion
There is a need for a prudently planned exit from the fiscal stimulus. A phased rollback of the stimulus is essential to maintain a balance between delivering sustainable growth and stabilizing the economy. A hastily worked out stimulus could end up being disastrous and counter-productive for the industry. There also needs to be greater coordination between fiscal and monetary exits to avoid conflicting results between them. We need to understand that we are not out of the woods yet and that the darkness might prevail for a longer time tha
Friday, April 9, 2010
Tuesday, January 26, 2010
Lessons from a decade of financial misfortunes
This decade has been quite fascinating to say the least. It ended with a recession at its tail quite similar to the way it had started off with. The IT bubble gave way to the real estate bubble both of which burst with equal tenacity leaving the taxpayer at the mercy of the Capitalist system. As these huge financial institutions gambled away the savings of the common man, the brunt of the losses was borne by the hapless tax payer who was left in a lose-lose situation .The cherry on the other hand was taken by the few who actually recklessly gambled away the savings of the many who diligently paid their dues to society. An insight into these financial crises gives us an understanding of what happened, how it happened and why it happened as these are a critical part of stabilizing the financial system in the long run.
The learnings from these crises are one too many but the biggest of all has been that of the importance of regulation in our financial markets. Without adequate regulation markets become susceptible to manipulation and lose their self correction mechanisms. The invisible hand remains invariably invisible.
As in the case of the recent Global financial crisis the “invincible” sector – Real Estate also revealed the mess that was underneath the massive housing market. Right from the late 1990’s to the mid 2000’s housing prices in US rose at a CAGR of 8%. The expansionary monetary policy followed by the Clinton administration led to extremely low lending rates due to which more and more people were able to afford houses thus leading to growth in the economy in general.
But this growth was temporary as the housing bubble burst sending a ripple effect throughout the financial system. Default on mortgages and foreclosures became commonplace, thus leading to a credit crunch for the banks that had lent out these subprime loans. Soon these banks went insolvent which triggered the downward spiral that engulfed the entire global financial system. Globalization of these toxic assets made this the local problem global. Thus an understanding of complex financial products requires great expertise and judgment.
During the first half of this decade American-style consumption offered a new model of economic development. The world revolved around American consumerism. During the recession the savings rate of the debt ridden economies shot up due to reduction in disposable income of these economies. This led to a further deepening of the crises while revealing the massive overcapacity of the US retail market. So while the last decade was an age of Consumerism the next one is sure to be one of the Service Economy which would emphasize human interaction more than individualistic consumption.
Another learning from these difficult times has been the impact of labour and financial markets on the economy. The inefficiencies of the labour markets lead to escalated costs on society. On the other hand capital market failures strongly affect the labour markets. The recent global recession has left the United States with approximately 8 million jobless while the global unemployment levels have reached to around 220 million. Such weakness in the job market takes a huge toll on economic and personal well-being.
We also know that not all innovation leads to a more efficient and productive economy. Financial engineering did not create products that would help ordinary citizens manage the simple risk of home ownership. Instead, innovation was directed at perfecting the exploitation of those who are less educated, and at circumventing the regulations and accounting standards that were designed to make markets more efficient and stable. As a result, financial markets, which are supposed to manage risk and allocate capital efficiently, created risk and misallocated wildly. Thus to check the excessive leverage of the last decade, stiffer capital adequacy norms need to be put in place.
In the current crisis, China, India, and certain other emerging-market countries are coping fairly well. These countries all had strong external balance sheets and ample room for fiscal maneuver before the crisis, which allowed them to apply countercyclical policies to combat external shocks. They have also nurtured industries in line with their comparative advantage, which has helped them weather the storm. In today’s competitive global marketplace, countries need to upgrade and diversify their industries continuously according to their changing environments. The focus now should be on establishing well-functioning markets that enable developing countries to fully tap their economies’ comparative advantage.
With the advent of globalization, integration and synchronization of the business cycles across the world has become a common fact. It has its pros as well as its cons. Increased financial integration can lead to a positive effect on the exports of neighbouring countries through inter-linkages between monetary policies of these nations. On the other hand we can also have demand shocks in one country severely affecting the output of another. As was the case when the demand in US declined it affected the exports of India and as well as China immensely. The developing economies need to build up their own demand levels and reduce the burden on exports to mitigate the impact of such crisis on their growing economies. Decoupling of major economies is not a viable option as the self-sustained growth can only be possible after decades of superlative growth.
All in all this decade has proven to be one of great hurdles which have taught us important lessons about the role of greed and fear in the markets. We need to take our learnings forward and make sure that the next decade can handle all the impediments that come across its path.
The learnings from these crises are one too many but the biggest of all has been that of the importance of regulation in our financial markets. Without adequate regulation markets become susceptible to manipulation and lose their self correction mechanisms. The invisible hand remains invariably invisible.
As in the case of the recent Global financial crisis the “invincible” sector – Real Estate also revealed the mess that was underneath the massive housing market. Right from the late 1990’s to the mid 2000’s housing prices in US rose at a CAGR of 8%. The expansionary monetary policy followed by the Clinton administration led to extremely low lending rates due to which more and more people were able to afford houses thus leading to growth in the economy in general.
But this growth was temporary as the housing bubble burst sending a ripple effect throughout the financial system. Default on mortgages and foreclosures became commonplace, thus leading to a credit crunch for the banks that had lent out these subprime loans. Soon these banks went insolvent which triggered the downward spiral that engulfed the entire global financial system. Globalization of these toxic assets made this the local problem global. Thus an understanding of complex financial products requires great expertise and judgment.
During the first half of this decade American-style consumption offered a new model of economic development. The world revolved around American consumerism. During the recession the savings rate of the debt ridden economies shot up due to reduction in disposable income of these economies. This led to a further deepening of the crises while revealing the massive overcapacity of the US retail market. So while the last decade was an age of Consumerism the next one is sure to be one of the Service Economy which would emphasize human interaction more than individualistic consumption.
Another learning from these difficult times has been the impact of labour and financial markets on the economy. The inefficiencies of the labour markets lead to escalated costs on society. On the other hand capital market failures strongly affect the labour markets. The recent global recession has left the United States with approximately 8 million jobless while the global unemployment levels have reached to around 220 million. Such weakness in the job market takes a huge toll on economic and personal well-being.
We also know that not all innovation leads to a more efficient and productive economy. Financial engineering did not create products that would help ordinary citizens manage the simple risk of home ownership. Instead, innovation was directed at perfecting the exploitation of those who are less educated, and at circumventing the regulations and accounting standards that were designed to make markets more efficient and stable. As a result, financial markets, which are supposed to manage risk and allocate capital efficiently, created risk and misallocated wildly. Thus to check the excessive leverage of the last decade, stiffer capital adequacy norms need to be put in place.
In the current crisis, China, India, and certain other emerging-market countries are coping fairly well. These countries all had strong external balance sheets and ample room for fiscal maneuver before the crisis, which allowed them to apply countercyclical policies to combat external shocks. They have also nurtured industries in line with their comparative advantage, which has helped them weather the storm. In today’s competitive global marketplace, countries need to upgrade and diversify their industries continuously according to their changing environments. The focus now should be on establishing well-functioning markets that enable developing countries to fully tap their economies’ comparative advantage.
With the advent of globalization, integration and synchronization of the business cycles across the world has become a common fact. It has its pros as well as its cons. Increased financial integration can lead to a positive effect on the exports of neighbouring countries through inter-linkages between monetary policies of these nations. On the other hand we can also have demand shocks in one country severely affecting the output of another. As was the case when the demand in US declined it affected the exports of India and as well as China immensely. The developing economies need to build up their own demand levels and reduce the burden on exports to mitigate the impact of such crisis on their growing economies. Decoupling of major economies is not a viable option as the self-sustained growth can only be possible after decades of superlative growth.
All in all this decade has proven to be one of great hurdles which have taught us important lessons about the role of greed and fear in the markets. We need to take our learnings forward and make sure that the next decade can handle all the impediments that come across its path.
Monday, January 25, 2010
Economic Renaissance should take precedence over ecological imbalance
The recent financial crisis has put the great economies of the world under immense pressure to rebuild and restructure their financial structures. It demands a comprehensive strategy from all the major countries to restore the growth momentum of the earlier decade. At this stage of the economic cycle the emphasis should only be on kick starting an economic renaissance. Entangling ourselves in the hue and cry over environmental sustainability will only inhibit our efforts in restoring the economy.
We have almost half the world living at less than $2.5 a day. The main concern of these 3 billion people is food security and that can only be attained through economic growth. For poor countries ecological impact takes a back seat as human survival becomes a priority. Even for the developing countries maintaining their growth momentum involves building on their competitiveness which can be marred by environmental constraints. The pioneer in the field of sustainable development should be the rich developed countries which have the necessary resources and technological expertise to explore renewable energy resources and to utilize them efficiently. But sadly even the US, the largest economy in the world, has not ratified the Kyoto Protocol even though it is the largest contributor of greenhouse gases in the world.
We should understand that the topic here talks about giving precedence to growth aspects of the economy and is not concerned with underpinning the environmental sustainability. Both these aspects need to be considered while chalking out a successful business model. The government also needs to be proactive in its approach towards sustaining the environment. Any company which is losing out on its competitiveness due to environmental friendly policies should be provided with the required stimulus to sustain its eco friendly outlook. Giving precedence to environmental aspects without understanding the financial implications of the same can be catastrophic for any business.
The main concern of the environmentalists should not be to stall the growth process rather it should be to develop sustainable energy resources for the future generations. The focus should be on developing cost effective solutions which are competitive in the free market and do not require any subsidies for implementation. They should work towards making global energy supply more efficient while reducing consumer demand for polluting goods and promoting cleaner energy and transport technology.
Be it Kyoto or Copenhagen, there has never been a reconciliation between ecological concerns and economic growth. The current economic scenario is not potent enough to stand any further ecological restrictions. Any attempts to do so might prove to be catastrophic.
We have almost half the world living at less than $2.5 a day. The main concern of these 3 billion people is food security and that can only be attained through economic growth. For poor countries ecological impact takes a back seat as human survival becomes a priority. Even for the developing countries maintaining their growth momentum involves building on their competitiveness which can be marred by environmental constraints. The pioneer in the field of sustainable development should be the rich developed countries which have the necessary resources and technological expertise to explore renewable energy resources and to utilize them efficiently. But sadly even the US, the largest economy in the world, has not ratified the Kyoto Protocol even though it is the largest contributor of greenhouse gases in the world.
We should understand that the topic here talks about giving precedence to growth aspects of the economy and is not concerned with underpinning the environmental sustainability. Both these aspects need to be considered while chalking out a successful business model. The government also needs to be proactive in its approach towards sustaining the environment. Any company which is losing out on its competitiveness due to environmental friendly policies should be provided with the required stimulus to sustain its eco friendly outlook. Giving precedence to environmental aspects without understanding the financial implications of the same can be catastrophic for any business.
The main concern of the environmentalists should not be to stall the growth process rather it should be to develop sustainable energy resources for the future generations. The focus should be on developing cost effective solutions which are competitive in the free market and do not require any subsidies for implementation. They should work towards making global energy supply more efficient while reducing consumer demand for polluting goods and promoting cleaner energy and transport technology.
Be it Kyoto or Copenhagen, there has never been a reconciliation between ecological concerns and economic growth. The current economic scenario is not potent enough to stand any further ecological restrictions. Any attempts to do so might prove to be catastrophic.
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