Even as it projected another year of robust global growth led by China and India, the United Nations Conference on Trade and Development (Unctad) has cautioned that a recession in the United States could reverse a lot of these gains.
“Given their (China and India) high investment ratios, this pattern is likely to continue in the years to come, provided that the inevitable correction of global imbalances does not occur at the expense of a major recession in the United States, one of the largest markets for Asian exports,” Unctad said in its 2007 annual report.
While global growth is projected at 3.4%, Unctad expects India to grow at 8.5%, similar to the forecast made by the Reserve Bank of India, and China at 10.5%. Growth was unexpectedly strong at 9.3% in the first quarter of 2007-08 in India, though analysts still expect it to moderate in the second half.
The report notes that the boom in commodity markets has continued, with the growth in non-fuel commodity prices rising by 30.6% in 2006 — the highest since the boom began in 2002.
The report says as global financial imbalances and volatility would continue, developing countries could look at increasing trade and financial cooperation with neighbours, including regional payment and mutual credit agreements to ensure a soft landing in the event of a crisis.
The Asian Development Bank has been working towards a common Asian currency, on the lines of the Euro of the European Union.
However, according to Rajiv Kumar, chief executive of Indian Council of Resarch on International Economic Relations, “A new global financial arragement is essentially a pie in the sky at this stage. Even the Asian Currency Unit, which is in the realm of possibility, will take a long time to happen.”
The inherent problem with such arrangements, he feels, is that it is to the advantage of the weaker countries and stronger countries are therefore lukewarm to it.
The Unctad recommendations come amid disruptions in the US housing finance market, which has led to a repricing of risk in credit markets, and this is feared to depress funds flows to emerging markets. A new Standard & Poor’s global report expects “significant bank loan and securities mark downs, reduced earnings in investment banking and trading, and increased credit losses in the second half of 2007 in the global financial markets.”
The Unctad report also cautions developing countries against the rapid proliferation of trade agreements with developed countries. The number of such regional and bilateral arrangements reported to the World Trade Organization increased from 86 in 2000 to 159 in 2007.
Cooperating with neighbours instead, the report argues, would help developing countries to cushion themselves against the inevitable and imminent correction of global financial imbalances caused by the US and some other countries running a huge trade and current account deficit for long. This has, in part, resulted in many developing economies running a corresponding current account surplus.
At $19.3 billion, or 2.1% of gross domestic product and a real effective exchange rate (REER) of 100.4, India is among the countries with larger current account deficits, says the report. The REER is the country’s nominal exchange rate discounted by the inflation rate.
The US current account account deficit at over $850 billion is 6.6% of GDP. The current account deficit is 5.4% of GDP for Australia, 3.5% for UK and 4.7% for the European Union. In contrast, China is running a huge surplus of 10.3% (at an REER of 109.9), Russia at 9.6% and Japan at 3.9%.
The difference in the REER is encouraging widespread speculation via “carry trades” that allow dealers to profit from the difference in exchange rates of two countries, especially if they have quasi-fixed monetary policies, “inducing huge amounts of capital flows and and pressure on exchange rates since the early 70s”, the report says.
The way it works is that speculators borrow in low interest regimes such as Japan and then invest the proceeds in another country such as the United States. Not only do they make profits from this interest arbitrage, they also notch up gains that accrue as exchange rate differentials when the investment is encashed and the proceeds repatriated to Japan.
“In today’s markets, the volume of speculative flows stemming from these funds is so large that they have a direct effect on the exchange rate, thereby creating a self-fulfilling expectation of profit in excess of the interest rate differential,” the report said.
This is the main reason, Unctad thinks, why countries with current account surplus such as Japan or Switzerland have seen depreciation in real terms and deficit countries, such as Brazil, have seen an appreciation, and currencies such as the Brazilian Real and the Turkish Lira have suddenly become very attractive.
However, Nagesh Kumar, director general, Research & Information Systems for Developing Countries (RIS), an independent think-tank, says India is relatively cushioned against such speculative impacts on currency. He also feels India is well-placed for a soft landing, since most of its growth and investment is domestic consumption-driven.
Kumar, who feels growth rate would cross 9% in 2007 too, says the Unctad report is right in warning developing countries against the dangers of financial adjustment and frame policies in advance. But, he adds, the pressure on the Indian rupee is nowhere near what has been experienced in Japan where the yen appreciated from 364 per dollar to 90 per dollar or in Brazil where the Real doubled in value. Yet, he says, their exporters have managed to do well.
He says exporters would simply have to find ways to adjust with the twin problems: a possible slowdown in buying markets and a appreciating rupee against the dollar. “Indian exporters will just have to learn to live with a stronger rupee,” he said.