Emerging economies syncronise with advanced economies in global downturn
The March World Risk Developments newsletter of Australia’s export credit agency, EFIC – released today – says that Eastern Europe is looking crisis prone; the Japanese economy has had its largest single quarter contraction since the 1974 oil shock; and two scenarios for the world economy are in contention – one suggesting a two-year climb-back to trend growth; the other, a more prolonged slog as households and financial service firms de-gear.
Highlights
- Japan’s Q4 GDP drop sharpest in 35 years
- Eurozone and the UK contract at same pace as the US
- Western Europe's banking exposure to Eastern Europe becomes problematic
- Policymakers pulling out all stops to revive economic growth
Emerging economies synchronise with advanced economies
EFIC Chief Economist, Roger Donnelly says the most vulnerable countries in Eastern Europe and the former Soviet Union – including the Baltic states, Bulgaria, Romania, and the Ukraine – look distinctly crisis-prone.
“Growth in Eastern Europe and Russia turned around from a 5% annualised rate in Q3 2008 to around -8% in Q4. It looks quite possible that all Eastern European countries will experience full-year contractions in 2009.”
“Strong trade links and capital flows between West and East Europe are placing both at risk,” says Donnelly.
The slump in the West is undermining Eastern European exports, while Western European banks’ waning enthusiasm for refinancing foreign currency loans is triggering sharp currency depreciations.
In the other direction, the exposure of Western European banks to the troubled East is intensifying the credit crunch in the West.
“There are concerns that some Western European banks will withdraw support from their Eastern European subsidiaries, further weakening Eastern European currencies and banking systems, thereby causing additional ricochet effects.”
Recent data also point to sharp contractions in trade, industrial production and GDP in Q4 2008, even in East Asia, which was supposed to be able to defy the international downturn.
“Pre-collapse, it made sense to speak of ‘decoupling’, with emerging economies outgrowing by a considerable margin advanced ones. But in Q4 2008, advanced and emerging economies alike seem to have contracted.”
“'Recoupling' – and ‘synchronicity’ – have become the new watchwords,” says Donnelly.
In Q4 2008 Korea shrank at an almost 21% annualised rate, Taiwan at 17% and Russia at 14%. No major region escaped; all experienced sharp downturns.
Among advanced economies, the largest contractions in Q4 occurred in Singapore, which dropped at a 17% annualised pace, the biggest in its history, and Japan at a 13% rate. For Japan, this is the fastest pace since the recession of 1974, which was triggered by the first OPEC oil shock.
“The Japanese slump represents a big drag on world economic activity, because Japan, as the world’s second largest economy, constitutes 8% of world GDP.”
Policymakers pull out all the stops
“Discretionary fiscal policy looks as if will add about 2-3% to world GDP in both 2009 and 2010, says Donnelly,
The US fiscal package is expected to add more than 2% to US GDP in 2009.
“Governments have taken unprecedented action to support their financial sectors, increasing liquidity, taking equity stakes in financial institutions and providing government guarantees.”
“While more needs to be done, the functioning of financial markets appears to have improved,” says Donnelly.
Two views of the world economy
The more conventional view acknowledges that because of over-borrowing and irrational exuberance the previous worldwide boom has culminated in a crash.
But it notes that just as all booms end, so too do the subsequent crashes and slumps. Market forces in the form of inventory and asset price adjustment will do a lot to revive economic activity.
Government liquidity and capital injections into banks plus purchases of ‘toxic’ assets will make banks willing and able to lend again. Interest rate cuts will make companies and households willing and able to borrow again.
Fiscal stimulus will fill the hole left by private spending cuts, ensuring that production soon recovers to its potential.
“On this view, the world economy should be climbing back to its trend growth path by at latest end-2010,” says Donnelly.
The more pessimistic view, espoused by the likes of the Financial Times journalist Martin Wolf and economist Wynne Godley of the Levy Institute, is that the spending cuts and debt repayment needed to restore solvency to many private sector balance sheets are so large and will be so drawn-out that no amount of government intervention can feasibly compensate for the resultant demand shortfall.
“For instance, Godley calculates that for private debt in the US to fall back to 130% of GDP by 2013 – its pre-2000 level – the private sector would have to swing round from running an annual financial deficit of 4% of GDP, as it did pre-crisis, to a surplus of 8% of GDP,” says Donnelly.
Godley argues that it is difficult to conceive any fiscal or net export expansion that would compensate for this demand decline – even in a world of coordinated policy intervention. Therefore, the US economy, and by extension the world economy, could be in for a prolonged bout of stagnation.
Donnelly notes, “As the extent of the financial imbalances that accumulated during the boom years become more and more apparent, it seems appropriate to prepare for the second scenario – even while hoping for the first!”
About World Risk Developments
EFIC’s World Risk Developments bulletin provides regular assessments of developments in the world economy and emerging markets. To read the full newsletter and to sign on for an e-mail subscription, go to www.efic.gov.au/wrd.
About Export Finance and Insurance Corporation (EFIC)
EFIC, Australia’s export credit agency, provides specialist finance and insurance services to Australian companies exporting and investing overseas. EFIC is a self-funding, statutory corporation that provides services beyond what is available in commercial markets.