C.R.L. Narasimhan

A slowdown or recession?

Mumbai: RBI Governor Raghuram Rajan at a press conference in Mumbai on Tuesday. PTI Photo by Shashank Parade (PTI6_2_2015_000071B)   | Photo Credit: PTI

The RBI Governor, Raghuram Rajan, has very good credentials to talk about the state of the global economy. A former chief economist of the IMF, Dr. Rajan is among the very few who foresaw the great financial crisis of 2008 triggered by the collapse of the iconic investment bank Lehman Brothers. His performance at the RBI needs no major elucidation. Taking over the stewardship of the central bank at a difficult time, he managed to stabilise the macro-economy fairly quickly.

All these as well as his academic credentials ensure that his views and comments on the global economy would be listened to with more than ordinary interest. This explains why a speech delivered at an academic forum, the London Business School, should have such a tremendous impact on the financial markets that the RBI subsequently sought to “moderate” the tenor of the speech.

As reported by the PTI, Dr. Rajan had warned of the global economy slipping into problems reminiscent of the Great Depression of the 1930s. He had urged central banks from across the globe to “define the rules of the game” to find a solution It is not for the first time that he had recommended such a course of action.

The problems are not confined to the rich or emerging markets but encompass the world.

As per the clarification provided by the RBI, the Governor was not suggesting that a Great Depression was round the corner. In his speech, he had drawn attention to the “beggar thy neighbour policies” that ruined the world economy in the 1930s. Those practices are once again being followed in some advanced countries. These countries are deliberately keeping their currencies weak for the sake of export competitiveness which ultimately benefits no one.

Premature optimism

Dr. Rajan’s speech might have been out of context and interpreted to be an advance warning of a great depression. But it has spawned a debate on the state of the global economy — whether at the next turn of the cycle, the world economy will slowdown but escape a recession or what is worse a general depression.

There is some basis to be less than optimistic about the state of the global economy. This view is despite the fact that after a long time, there are signs of recovery across the globe, notwithstanding problems in Europe. In the rich world, the fight against deflation is won. According to the IMF, in 2015, every rich country will expand. The Federal Reserve will very likely raise interest rates from their rock bottom levels, thereby vindicating its belief in sustained recovery and reduction in unemployment. Most other data also support the view that the U.S. economy is well and truly on the mend.

The good news extends in varying degrees to other rich countries. In the euro zone, unemployment is down and prices have been rising. It is a very important development considering the threat of deflation that had very recently threatened many countries in the region. There are definite expansionary signs in the U.K. Recent released figures show broad-based growth in Japan.

There are, however, weaknesses which cannot be ignored. Europe is deeply in debt and dependent on exports. In the U.S., a fall in unemployment would mean higher wages. That could eat into profitability of companies and bring down valuations. Japan is still combating deflation. Emerging economies, including India and China which were in the forefront of global recovery in the post-crisis years, have ceded leadership.

Exhausting all ammunition

Quite ominously, the unorthodox policies that have benefited rich countries such as the ultra-monetary stance of the U.S. Federal Reserve may not be available when the next downturn occurs.

To many economists and policy makers, the inevitability of a slowdown is not in doubt but there is no agreement on the nomenclature be used — recession or the more severe depression.

The denouement in Greece will be the time to reassess individual economies; strengths and weaknesses. For India, the solution is to step up public investment, especially in infrastructure projects and stimulate private investment. India’s competitiveness in merchandise exports and services should be enhanced to gain a larger share.

Getting back to the main theme of this article, recession or worse — the view that we are heading to something as severe as a global depression is by no means extreme.

An informed debt market trader with a leading financial institution is pessimistic for the following reasons: Governments are stretched on debt/GDP; asset prices reflect investor money rather than the real economy; global unemployment at peak levels; cash rich companies not sufficiently incentivised to put their money to work; banking sector (as in India) burdened with non-performing assets and constrained for growth; and, most importantly, with central banks having zero space for additional support, there is really no economic agent having the space for real economic activity.


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