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Global Economy: In a fix! - Views on News from Equitymaster
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  • Sep 27, 2004

    Global Economy: In a fix!

    The recently released Trade and Development Report (2004) from UNCTAD seems to offer confusing signals. Things would become clear when one goes through the two contradictory paragraphs that clearly demonstrate how the leading economic agencies of the world are undecided what route the global economy will take in times to come.

    The introductory paragraph of the report states, "The situation of the global economy is brighter than it was a year ago. Since growth in world output and trade recovered in 2003, there is now widespread optimism that the acceleration of growth in 2004 could lead to a return of the performance experienced at the end of the last decade and that the world economy may enter an extended period of growth."

    Now read the following paragraph.

    "In reality, however, the outlook for a sustained recovery is more clouded and uncertain than at the beginning of the 1990s. Large disparities in the strength of domestic demand persist among the major industrial countries, and increasing trade imbalances between the major economic blocks could lead to new protectionist pressures and increase instability in currency and financial markets, with adverse implications for developing countries."

    While the report goes on to define extensively the factors that will lead the global economy towards higher growth in the future, it deserves no blame for the ambiguity over the sustenance of this growth. There are actually several factors acting in concert in these times that have the capability to stymie the momentum. Among them, at least in the short to medium term, top priority can be accorded to the sharp increase in oil and commodity prices and uncertainty about their future development. Also, the possible impact of these rising input costs and their consequent effects on inflation and interest rates across nations, can be seen as additional reasons for concern.

    Trade and Development Report 2004, UNCTAD

    While the above graph captures the rise in commodity prices till the year ending December 2003, there is no doubt that one could simply extrapolate to get a higher figure for 2004. The increase in commodity prices and the consequent rise in inflation have sounded alarm bells for a large number of central banks worldwide. Among the first to react have been the Bank of England, the Reserve Bank of Australia and the US Federal Reserve, the latter having raised its overnight rates by quarter of a percent, to 1.75%, just a couple of days back.

    While this kind of a response seems to be across expected lines, investors shall do well to understand that the global economy is not the same any more. It is now more integrated, more globalised than ever before. And, very importantly, developing countries have taken the mantle from developed countries to lead the growth of the global economy. This is vindicated by the fact that origins of global trade have now shifted from developed regions to the developing world.

    The reports states that between 1990 and 2000, on average, around 70% of total exports originated in developed countries (including intra-EU trade), and only 25% in developing countries. On the contrary, the recovery of global trade since 2000 has been propelled mainly by developing countries. As a matter of fact, in 2003, developed countries accounted for 21% of the increase in export volumes while developing counties (especially in East and South Asia) accounted for 66%. In short, the developing world has emerged as the factory for the developed world (read, the US).

    Now comes the cause for concern. The developing regions of East and South Asia (excluding India) have been so 'engrossed' in being the manufacturing hub for the developed world (read again, the US) with all their low cost offerings, that they have almost failed to give heed to a more fundamental factor of growth - the internal demand. As a result, countries like South Korea are currently facing the threat of deflation as the demand for industrial goods has failed to pick up in the economy. On the contrary, the highly indebted and saving short US consumer is facing the double threat of rising inflation and consequent rise in borrowing costs. Job losses on account of US corporations' increasing move towards outsourcing have also put a question mark over the US consumer spending.

    What makes US inflation grave is the fact that the world economy depends to a very large extent on the US consumer demand. And if they reduce consumption (or over-consumption!), export-led economic growth of the developing regions might take a hit.

    The inflationary pressure is, however, not peculiar to the US economy alone. Rising commodity and crude prices have cast an inflationary pressure on India as well. While the RBI seems to have cleared its stance by raising the CRR, the industry and consumers are now looking at what the central bank does in the upcoming mid-term review of the monetary policy.

    All said and done, Indian investors need to take solace from the fact that the economy is not heavily dependent on the US and other global consumers for growth. As a matter of fact, the report states that domestic private consumption has been the highest contributor to India's GDP growth over the past three years and that the same is likely to continue going forward.

    While a greater integration with the global economy will continue to affect India's economic progress going forward, investors need to consider the changing population mix in the country. The rising middle class and a greater proportion of the younger population can act as a huge consumer base in the future and this can act as a hedge against increased volatility due to deepening integration with the world economy.



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