Is the world economy headed for another bout of trouble?
One popular indicator is flashing red, but too much should not be read into the recent crash of the Baltic Dry Index, which measured the changes in the cost to transport raw materials such as metals and grain by sea. The index fell by 66.5% from mid-December to mid-February.
The freight index can be used as a proxy for economic activity as commodities shipped help in the production of finished goods. Such a steep decline in the index is being taken as a harbinger of weaker economic activity. But if history is anything to go by, there is nothing to be worried about. Similar declines in freight rates did not indicate imminent recessions in 2004, 2005, 2010 or 2011.
According to the Round Table of International Shipping Associations, a body representing ship owners across the world, the slump in freight rates is being caused by a vessel surplus rather than a contracting world economy.
As historically capacity always remained tight and supply was seen to be inelastic, slight change in demand often resulted in rapid changes in shipping rates. This led to a surge in shipping rates as measured by the Baltic Dry Index with growing demand for commodities before the financial crisis. Optimistic ship owners ordered a vast fleet just before the credit crunch of 2007. As it takes 2-3 years before a ship is delivered to a fleet wonder, most of the ships came into the market after 2010. Though the demand for various commodities started growing from 2010, the growth of shipping supply was much faster. The ensuing gap between demand and supply has led to the steep fall in shipping rates.
The other big factor has been the slowdown in China, especially the reduction in iron ore imports because of the inventory mountain that has been built up in that country. The reduction in Chinese demand for commodities can also be attributed to the Chinese New Year’s Golden Week, which lasts for 15 days and includes three public holidays, with workers allowed to take Sundays off. This year New Year was celebrated on 23 January, and the festival lasted till 6 February. Hence demand is expected to pick up from February, and might put upward pressure on the Baltic Dry Index in the coming days.