Great Recession to just another regular recession?
19 Jun 2009
It is not yet the storm season in the Atlantic, when threatening storms are given nice and sometimes even adorable names. Once named, they develop a persona and become celebrities as entire populations closely follow their mood swings. Usually, these storms pick up strength when they are above the ocean and are regardd as potential threats on landfall.
But, most often, they lose steam and are steadily downgraded as they move closer to land. Many of them are eventually relegated to just a tropical squall, possibly the worst insult for a beast that started life as a potential hurricane. The varying prospects of the global economic decline over the last several months mirror the life of a typical tropical storm.
Until March this year, the world believed it was staring at the worst economic decline since the Great Depression. Some of us were even secretly excited about the whole experience. After all, it is not very often that we get a global depression and only very few generations get to live through a depression to tell their grandchildren about it.
When it became clear that this downturn was going to be nowhere close to the Great Depression in terms of viciousness and human suffering, economists downgraded the threat to a Great Recession. Now that was not very original. Economists had to come up with something new because the downturn was not quite a depression, but worse than a regular recession and hence needed to be reverentially addressed as 'great'.
Even that didn't hold. In the face of fresh evidence in the form of upside surprises in economic data, economists are busy relegating the Great Recession to just another severe recession. Consumer confidence is looking up, manufacturing activity is not dropping anymore, commodity prices are up, freight rates have recovered, housing markets are stabilising, banks are reporting profits, and stocks are soaring. The sentiment has turned so much that central banks are now worried about inflation, not deflation. In fact, there are so many green shoots of economic recovery sprouting all over the troubled economies that the world may even appear to have turned greener than before.
Even the big pessimists, Nouriel Roubini who correctly predicted the economic collapse and Paul Krugman who is the latest Nobel laureate for economics, have changed their views somewhat. Since his worst case scenario has not yet played out, Roubini's celebrity status has dulled a bit and Krugman is busy espousing and defending Obamanomics. Both now accept that a recovery may be on its way, though it will be long drawn out and far from smooth.
So, where exactly are we and where are we headed?
To see if this recovery is indeed the real one and is sustainable, we should start from the immediate reasons behind it. First is the massive infusion of liquidity and market intervention by the biggest central banks, which have stabilised the financial system and restored near-normalcy in credit markets.
Second, the large government capital infusions into troubled banks, insurance companies and car companies - both in the US and Europe. These measures prevented these companies from collapsing, at least for the time being, and pulling down other businesses with them.
Finally, the dramatic scaling up of public spending in places like China that prevented global demand from slumping further.
India remained relatively unscathed because even before the global recession worsened, we had stimulus measures in place in the form of the rural jobs programme and the farm loan write-offs.
The first big question is, has the recovery gathered enough momentum so that the global economy will not plunge again if the drivers mentioned above are removed? Almost all the indicators, which appear to have bottomed out or have shown improvement until now, are driven by higher government spending or the huge amount of liquidity floating in the global financial system. True, consumer confidence indicators have improved - especially in the US and select other developed economies. But, until these economies start adding new jobs, consumer sentiment is likely to be weighed down by higher unemployment. If oil prices remain at these levels and interest rates trend higher, consumer outlook may turn weak again.
Higher consumer spending in countries like China and India are almost entirely because of tax sops or other forms of 'encouragement' by the government. For instance, car sales in China have soared this year, because the government offered tax cuts and asked the banks to be more liberal with credit. The massive increase in government spending in rural areas has absorbed part of the workforce laid off from the export sector.
Brazil saw a similar increase in car sales until March, but volume growth declined after the tax cuts were removed. In India, it is evident that the recovery in industrial output growth is supported by higher public spending and the pay commission bonanza to government employees. Also, India's export sector was relatively less affected when compared to China because of the weak rupee.
This is not to say that this recovery phase will not sustain long enough to allow real consumer spending to resume its role as the primary driver of economic activity. It may indeed. But, the data we have so far is insufficient to arrive at a definite conclusion.
The next big question is, if the global economy falters again, can governments in large economies launch another wave of stimulus measures? Difficult, if not impossible. There is not a single large economy which will not see a dramatic increase in fiscal deficit this year. Worsening public finances can bring the sovereign credit ratings of some of these economies, like the UK, under a cloud and limit their manoeuvrability.
China is possibly the best positioned with a forecast fiscal deficit of only around 3 per cent this year. But, that is without accounting for hidden costs like the potential increase in bad debts for the state-owned banks because of aggressive government-induced lending.
The central banks have almost exhausted their ability to ease interest rates further, including quantitative measures, without seriously damaging longer term price stability. More likely, some central banks may even look at rate hikes before this year is out.
Thanks to the aggressive policy measures, the worst of this recession is likely behind us and we can allow ourselves a sigh of relief. But, the budding euphoria is way too premature.