The GDP growth of several economies has come from growth in exports. While this would mean current account surplus and strong currency, it also means a straight pass-through of risks of a slow-down in the developed world, to these economies. CitiGroup estimates that the correlation between Asian exports and US lead indicators, which was 0.15 until 1997, is up 0.81 since then, indicating a high dependency on US growth rates. Gross exports as a percentage of GDP has increased for several Asian economies since 1997, the average number moving up from 52% in 1997 to 74% last year, according to CLSA research on Asian economies. What would a slowdown in US consumption mean to China and Japan is the question to ask. The next question would be about how Central bankers would respond to possible global transmission of slowdown in demand for goods and services. The constraints to policy can only make it more difficult for them.

If the US is constrained by its size and the enormity of its deficits and inability to save, Europe is constrained by the rigidities in its product and labour markets; China is constrained by the inability of its monetary policy to contain investment and monetary expansion; and the BoJ does not enjoy political support for its monetary policy stance yet.

The comfort from taming inflation numbers — which in any case were taking care of themselves from the global disinlationary forces we just discussed — could be soon lost to geopolitical factors that threaten to take oil to $100 per barrel. Central bankers could then find themselves in a situation that demands strategies for revival in a complex, intertwined world. Which is why it is too early to celebrate either the reigning in of inflation, or revival of growth. Little wonder that markets are spooked.

... contd.