Apologies for the morbid analogy, but it seemed appropriate. If a frog is placed in boiling water, it will jump out, but if it is placed in cold water that is slowly heated, it will not perceive the danger until it is too late. That is, it is difficult to realise regime change is under way until it is over.
And so it is with the prevailing sense of disquiet over emerging market economies worldwide. It is easy to argue that the commodity-exporting economies of Latin America, the Middle East and Europe are languishing because global commodity prices have plunged. Some of this reflects the policy-engineered decline in headline numbers as well as the resource intensity of China’s GDP growth, and some has to do with the increase in the supply of certain commodities, like crude oil. However, it is hard to explain why commodity-importing and manufactured good-exporting economies like China, India, Korea and Taiwan are not doing much better. These were supposed to have benefited not only from the fall in commodity prices but also from the increased demand as developed market economies recovered.
Developed market growth has recovered from an average of minus 0.3 per cent over 2008-10 to 1.7 per cent since 2011. In contrast, growth in Asia (excluding Japan) fell from 9 per cent to 6.5 per cent over the same period. Such a breakdown in correlation between developed and emerging market growth hasn’t happened in a long time. More importantly, global exports, which doubled from $2 trillion in 2003 to $4 trillion in 2008, have flatlined since 2011. Manufacturing export growth — the pride of this region — has been declining almost every quarter over the last four years. The venerated Asian supply chain that linked the region to the world via China lies broken for both manufacturing and raw material exports. More recently, while the 50 per cent drop in crude oil prices brought down the region’s inflation rates, raising household incomes and corporate margins substantially, households and corporations just saved these gains rather than spend them.
One could have attributed such seeming anomalies to quirks in the data if it wasn’t for the fact that this has been happening since at least 2011. The old export-led growth model that provided emerging markets the easy option of growing out of their troubles by plugging into the relentless expansion in global trade lies seriously fractured. Any reasonable empirical analysis will corroborate this. Neither monetary easing nor fiscal policy support is going to change this. China and India in 2008-09 and the Asean countries in 2011-12 tried doing so. Growth was lifted temporarily before it came crashing down, pushing the economy to the brink of crisis in India and Indonesia. What was left to show for that support was a pile of recognised or still-to-be-recognised bad loans.
Not just in India, but across the region, many have been disappointed with the miserly cuts in interest rates or increases in fiscal support that authorities have provided compared to the large decline in inflation or slowdown in growth. One can argue that the reluctance of central banks to provide more support reflects concerns over financial stability — a euphemism that covers anxiety over worsening credit quality in China and India to fears of capital outflows elsewhere. My suspicion, however, is that monetary authorities in the region have resigned themselves to the futility of such policy support in the absence of structural reform. And this is where the biggest concerns lie. Barring perhaps China, nowhere in the region is there even the acknowledgement by governments that perhaps the old growth model might not be working anymore, that it is time to liberalise internal product and capital markets and focus on domestic drivers to sustain future growth rather than depend on the generosity of strangers.
Take India. Does anyone really believe that another 25 or 50 basis points of rate cuts is going to materially increase investment or even consumption, given the structural bottlenecks in the economy? The only thing such rate cuts achieve is to spike equity prices for a week or two before we go back to asking for more.
Then there is the upcoming start of interest rate hikes in the United States. This is a global regime change. While markets continue to price in an easy pace of interest rate liberalisation and one can justify that India is well protected from a disruptive Federal Reserve liftoff, there is a real possibility that the regime change may not be orderly — because they seldom are. The Fed might be forced to normalise interest rates faster than it usually does or the market believes it will at present. We economists like to think in terms of economic adjustments that are smooth and linear, not because that’s true in reality, but because it is easy. Reality, on the other hand, is replete with abrupt and disorderly adjustments. Given this possibility and the enormity of the change, the right thing for responsible central banks (and fiscal authorities) is to hunker down and ride out the regime shift.
So my guess is that the RBI will not be cutting rates aggressively any time soon unless inflation collapses or the Fed liftoff and its subsequent interest rate increases are overly muted. Neither looks likely.
There is, however, a scenario where India’s interest rates can fall substantially over the medium term. This requires inflation to be brought down to the 4 per cent mark over 2016-17, as envisaged under the inflation-targeting arrangement. If this happens, both policy and bank interest rates will come down significantly on a sustained basis. Ironically, this requires continuing with relatively high rates now. India did this once under C. Rangarajan in the late 1990s, which led to sizeable rate cuts in the early 2000s and a sustained period of high growth later, as firms were forced to restructure and improve productivity, in part, because of the high cost of capital. But in those days, there was the wind of globalisation to ride on. This time, it will require more than just bringing down inflation, opening up a few more sectors to foreign investment, or tinkering with the tariff structure. It will need acknowledging that the world may not revert to the pre-2008 days, and that reforms have to be redesigned to account for this new and unfolding reality.
The writer is chief Asia economist, JP Morgan. Views are personal.
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