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Global: Time to hit the panic button? - Views on News from Equitymaster
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  • Aug 16, 2004

    Global: Time to hit the panic button?

    After a subdued performance for nearly three years, global economic activity was finally showing some distinct signs of revival at the beginning of this year. This optimism about the global economy emanated largely from a turnaround in the US and the robust growth outlook for emerging Asia. What's more, the International Monetary Fund (IMF), in its World Economic Outlook released in April this year, had expected a sharp rebound in global economic growth 2004 and maintenance of these growth levels well into 2005.

    These growth forecasts from the IMF, and other similar agencies, did seem to have taken into account key adverse factors like rising crude prices and interest rates, and global terrorism that could derail this sharp rebound in global economic growth. However, in the months that have followed, the effect that these factors could have on the global economy may differ in proportion from what the IMF had earlier expected. Let us take a look at these factors and see whether the projections need a re-look.

    Crude prices

    This is possibly the biggest factor that has the potential to sweep away all healthy expectations of a strong global economic growth in 2004 and 2005. Crude prices, internationally, are currently at their 21-year high. For instance, the Nymex crude futures, a benchmark of global crude prices, have crossed the US$ 46 per barrel mark for crude to be delivered in September 2004. This is indeed an unsustainable level if the global economy has to grow at a fast pace. In fact, Morgan Stanley's Global Economic Forum states, "There is a speculative excess in the oil market, and therefore that some drop of oil prices is likely in the short run. However, geology and statistics of production potential imply that the average real price of oil has risen. The oil market is asking the world to accelerate production, substitution, and - the only long term solution - innovation."

    Thus, it becomes amply clear that if not given heed by the global authority on oil, the OPEC, and all those agencies involved in the exploration and production of the black gold, the world is likely to move towards a long-term oil crisis. The need of the hour is, thus, innovation. Innovation in the way fresh oil is explored, and innovation in the way it is extracted. Only that could possibly solve the long-term mismatch between the demand and supply of oil in the world. Till that happens, oil blues may never completely go away.

    Interest rates

    This is probably acting as a second whammy for the recovery of the global economy. At a time when economies are reeling under the pressure of rising crude prices, the monetary tightening as envisaged by global central banks (like those in the US, UK and Australia) can possibly put the unbalanced global economy back on the razor's edge. The Federal Reserve, the US central bank, has already raised its overnight funds rate twice by a quarter percent each and the same now stands at 1.5%. What is more concerning is the fact that these recent interest rate hikes by the Fed have come about in the face of weakening fundamentals in the US economy. Some of these are poor addition to non-farm payrolls and consequently lower growth in personal consumption expenditure, and rapid inventory buildup at manufacturing and trade establishments.


    The most potent medium term disturbance to the global economic growth can be due to the resurfacing of global terrorism. Very recently, terrorist organisations had warned of possible attacks on offices of certain financial institutions like the IMF, World Bank and the New York Stock Exchange. If this were to turn to reality, the aftermath could tell a gruesome story.

    Our view

    The factors mentioned above pose a serious danger to the global economic growth in 2004 and 2005. In fact, the downside risks seem to outweigh those on the upside. Now, since most of these global factors are likely to have impact on the Indian economy as well (call it the sins of globalisation!), and solution for them requires time and patience, investors need to follow a bottom-up approach. No particular sector is extremely attractive or extremely unattractive. However, there are several companies that are trading at attractive long-term valuations and are likely to provide investors with adequate returns. So, pick and choose. And let the world do what it is destined to do!



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