Opinion Waiting for the recession

That’s not really surprising because US Treasury securities remain the largest liquid pool of assets,which is why central banks across the world,including that of China,prefer to hold them as part of their foreign currency reserves. Nevertheless,it is a fact that fear has gripped stock markets worldwide,with the US struggling to repay borrowings and revive a faltering economy,and the eurozone grappling with sovereign debt issues in Greece,Spain and Italy while buying back Irish and Portuguese bonds.

On Tuesday,the Fed chairman,Ben Bernanke,put out a rather subdued outlook for the US economy,which grew at just 1.3 per cent in the three months to June 2011. Bernanke said the Fed expected a somewhat slower pace of recovery over the coming quarters and added that the “downside risks to the economic outlook have increased”. As a policy response,the Fed is committed to keeping the benchmark interest rate at a record low,at least till mid-2013,to aid a recovery. Moreover,it is ready to do more by way of providing a fiscal stimulus and perhaps we will have a QE3 at some point,though hopefully not one that would once again push up prices of commodities. In any case,any stimulus would be significantly smaller than the $600 billion that was spent on QE2 with less of an impact. In economies like the UK,high inflation constrains central bankers from injecting too much liquidity into the system. Indeed,the Asian region is now more vulnerable to a slowdown,especially countries like Singapore,Taiwan,Hong Kong and South Korea where exports contribute significantly to the GDP.

Domestic demand is also beginning to moderate and the cost of capital will go up in an environment in which risk-aversion is rising. Moreover,high inflation will constrain central bankers from taking immediate measures to boost domestic demand — in China,the authorities have been continuously tightening money to tame inflation. However,most economies in Asia are fairly stable,unlike countries like Brazil where rising interest rates over the past year or so have seen pressures building in the credit cycle. In short,the forecast for global growth in 2011 of sub-3 per cent might be tweaked to a level closer to 2.5 per cent despite a sterling performance from China,which clocked a better-than-expected 9.5 per cent in the June 2011 quarter. The world is clearly slowing down and parts of it could well slip into a recession.

Surprisingly,that doesn’t seem to be showing up just yet in the prices of crude oil — which have recovered to levels of $106 per barrel after slipping to around $100 — probably because there is still a speculative element in the markets. That could turn out to be a bit of a problem especially in economies like India where the high prices of commodities hurt corporate profits and exacerbate the slowdown. So,while India may stand out in a world that is barely growing,because much of its GDP is derived from the home market than overseas,it would be mistaken to think that the slowdown elsewhere would leave the economy unscathed.

While GDP growth estimates have been pruned,with the consensus being around 7.5 per cent,the fact that the recovery in the US could take more time than anticipated and that commodity prices don’t seem to be coming off means this number could be revised. The very small increase in bank loans this year is one sign that companies are unsure of the future and,therefore,hesitant to grow their businesses. Unless companies start to invest in fresh capacity,it would be hard to sustain 8 per cent growth over a longer period. Unfortunately,risk-aversion is globally rising at a time when corporates may have wanted to tap the equity markets for capital; typically fund managers tend to stay away from emerging markets at times like these even when they are attractively valued after the correction. However,Indian industry is far less leveraged than it was in 2009. A more benign macroeconomic environment by the end of the year,once inflation tapers off and interest rates peak,should help corporates clock 15-16 per cent earnings growth this year. The long-term India story doesn’t seem to be in jeopardy but it could be a bit of a wait before foreign investors flock back.

The writer is resident editor,Mumbai,‘The Financial Express’
shobhana.subramanian@expressindia.com