Mumbai: It wasn’t supposed to come to this. After the financial crisis broke, policy makers in the advanced economies started on a programme of fiscal and monetary stimulus that was supposed not only to pull their economies back from the abyss, but also to ensure a steady of slow recovery. Well, four years after the crisis started, we’re back at the brink.
The problem with loose monetary policy in the US is that, in spite of very low interest rates, people do not want to borrow. So the various ‘quantitative easing’ measures of buying bonds-- QE1, QE2—have had little effect on the US economy. All they’ve done is boost asset prices and fatten bank profits.
As for fiscal policy, both the US and Europe are discovering there’s a limit to which they can increase public debt. Countries like Italy, Spain and Portugal are facing a bondholders’ revolt. The contagion is spreading to countries at the European ‘core’ as well.
At the same time, growth is slowing in both the US and Europe. US GDP grew by a mere 1.3% in the June quarter. In June, consumer spending fell for the first time since September 2009. The stock market crash could also affect growth, as investors feel poorer and spend less. What it could do to pension funds is even more worrying.
For the Eurozone, the Markit Composite Purchasing Managers’ index, which measures month-on-month expansion in both manufacturing and services, was near stagnation in July, when it slipped to its lowest reading since September 2009. The hopes of a second-half rebound have vanished.
What effect will all this have on India? One good thing is that leverage is low in the equity markets but high in the commodity markets, which is probably why crude oil prices have fallen so much.
That should be good for the economy and for inflation. On the other hand, a slowdown in Europe and the US will certainly affect exports and reinforce the slowdown in the domestic economy. The meltdown in the markets will mean that companies won’t be able to tap them to raise equity, so you can say good-bye to capital expansion.
True, India’s economy is relatively insular, so it will be one of the least affected countries in Asia, which could help from a portfolio allocation viewpoint. But that would come later---the current panic is leading to a flight to safety. Mutual funds in the US have very little cash, which means they will have to sell to meet redemptions.
A nasty US non-farm payroll number later on Friday could lead to a continuation of the sell-off. An optimistic reading may on the other hand lead to a bounce. But what is more important is that, almost three years after the Lehman collapse, all that the policy makers have been able to do is to paper over some of the larger cracks. If you’ve reached the limits of fiscal policy and monetary policy no longer works, how does the global economy get out of the crisis? What’s really scary is that policy makers are groping in the dark and seem to have no answers.