The global economy is crashing and here's how India can benefit from it

[Lonely Hermit]

The global economy is crashing and here's how India can benefit from it
by R Jagannathan Aug 25, 2015 17:02 IST

#China #Europe markets #European Union #Eurozone #Germany #HowThisWorks #Indian Economy #Investment #investors #markets #Sensex #USA #World economy

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• Greece is trashing about for survival; Japan kept the money-printing presses working overtime for more than a decade, but has, under Shinzo Abe, gone back to the same trick of monetary expansion; China, with its export engine struggling, has been extremely unsuccessful in shifting its emphasis to domestic consumption-led growth.
  
  Why isn’t the medicine working? And why are the markets crashing today? The answer is complex, but the following are the prime reasons for this failure by the world to cure itself after Lehman.
  
  First, the purpose of making money cheap was to ensure the credit markets do not choke up and prevent a recovery. But in the absence of a more fundamental re-balancing of real economy incentives and the return of covert mercantilism among countries, it is the financial markets that fed themselves on zero-cost money. Put another way, the cheap money was used by companies and financial institutions not to lend to companies creating jobs, but to make money from money – which means financial investments like stocks and bonds.
  
  
  AFP image.
  
  More financial wealth has been created over the last seven years than probably in the previous seven – and this when the world isn’t growing too strongly. The Dow Jones Industrial Average hit a new all-time high of 18,312 this May, up from the November 2008 low of less than 7,450.
  
  When there is so much money to be made from money, who in his right mind will put up factories and roads in the hope that they will yield a positive return? The sharp fall in the Dow over the last two sessions by nearly 1,600 points suggests that the smart money is trying to lock in its profits before it evaporates. In the process it is causing prices to over-correct. The same thing is happening with Indian stocks.
  
  Second, while keeping money cheap after Lehman was the right short-term response, the obvious mistake western governments made was to let monetary policy do all the hard work, and letting fiscal policy hibernate. If you want to revive growth, you need people to invest and consume, not speculate. When the private sector was unwilling to invest and people in excessive personal debts were trying to bring leverage levels down, the logical thing for the US to do was to invest in infrastructure – which is what India is trying to do now – in order to correct what is called a balance-sheet recession.
  
  By first world standards, US infrastructure sucks, and a half trillion dollars spent there would have done more to revive growth than spending the same in rescuing banks and no-hopers.
  
  This is where doctrinaire approaches to what government should do or not do does not help. When economic confidence wanes, the only entity that can act is the government, which technically can spend even without having the money. The Right may not like it, and the Left will crow, but that isn’t the point. When nothing works, the government has to work.
  
  The US government left the Fed to do the heavy lifting instead of chipping in with public investment boosters. The Tea Partyists and the Paul Krugmans and Occupy Wall Streeters got into a Left-Right argument which didn’t help.
  
  The same mistake in happening in Europe, where the European Union is prescribing more austerity and more spending cuts as a way to revive growth. This can’t happen easily in any democracy. Growth and deficits are inversely related; when growth rises, the fiscal deficit falls as more tax revenues get generated; when growth falters, it is foolish to ask governments to cut spending even more to balance budgets.
  
  This is the mistake P Chidambaram and his predecessor did, and this is the mistake Arun Jaitley is in danger of repeating if he does not take care. The trick is to get revenue spending down and boosting capital or plan spending. If the fiscal deficit grows or remains high only due to capital spending, it is money well spent.
  
  Third, the global rebalancing that should have happened after Lehman - where the strong exporting countries exported less and consumed more, and the high importers exported more and consumed less – has not happened. Both Germany and China – the two main problem countries – are stuck in currencies that are artificially undervalued. Germany is the most competitive country in the Eurozone, and as long as the zone retains its common currency, the rest of the EU cannot correct the imbalance.
  
  For Germany to import more, it has to get out of the Eurozone, or the weaker elements in the Eurozone have to exit and develop competitive currencies that reflect their true competitive abilities. In the case of China, its recent devaluation of the yuan shows that it is still in an export mindset. China should actually upvalue the yuan and allow more imports so that domestic consumption grows and helps the world. China and Germany have to change course to help the world.
  
  Fourth, the failure of this economic rebalancing is leading this time to entire countries coming close to collapse. The PIIGS (Portugal, Ireland, Italy, Greece and Spain) and the oil sheikhdoms are under threat as Chinese demand collapses, reducing commodity prices all over. As a Deutsche Bank study noted some time back, Saudi Arabia needs oil prices at $99.2 to fiscally break even.
  
  For Bahrain, Oman, Nigeria, Russia and Venezuela, the fiscal breakeven prices are $136, $101, $126, $100 and $162 respectively - prices that are unlikely to be attained in the next couple of years without a sharp drop in Opec and global output (or a sharp revival in global growth, both implausible for now).
  
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  An IMF report says that Iran, Iraq and Algeria need oil prices of over $100 a barrel to balance their budgets. So it is not only Greece, but entire other countries are threatened by the Chinese demand collapse. Little wonder, rogue elements like ISIS are stepping into the breach where countries are failing.
  
  
  Fifth, the Chinese are unable to grapple with the new challenges that come with becoming the world’s second largest economy and key driver of demand. Two issues are paramount: one, there is huge financial repression, where Chinese savers are paid low returns and the cheap money raised from them has been invested uneconomically in unwanted infrastructure; and two, while financial repression helped fund investment-led growth over the last three decades, today it is constricting consumption – which is what China needs to boost internal growth.
  
  Clearly, China has to do the opposite of what it is doing – cutting rates to boost growth. Instead it needs to raise lending rates so that overinvestment halts and consumption is given a boost. A China that consumes more (and invests less at home) will become the world’s growth engine once more.
  
  Sixth, India must use the opportunity provided by China’s problems to get its own growth engines revving. It must do five things. One, use higher taxation of cheap oil to boost government revenues for public investment. This situation of ever-cheap oil won’t last forever. Two, recapitalise and privatise some banks so that the lending cycle can resume. Three, generate resources for growth by shifting more subsidies to cash (after LPG, kerosene, food and fertiliser are obvious candidates for huge savings by eliminating wastage and mis-targeting).
  
  Four, get states to start moving on land and labour reforms, till the centre itself is able to act when its Rajya Sabha numbers are better. And five, consistently improve ease of doing business. There should be a permanent secretariat constantly liaising with business to eliminate the pain points.
  
  And what about the stock market, and where it is heading? Rest easy. If the rest of the world is going down, India will remain an obvious magnet. If the rupee falls, FII selling becomes uneconomic and inflows attractive. The reason for the sharp market fall is simple: when markets decide to move in one direction, they do so quickly. Falls that used to take months when information was slow to travel from the real economy to the financial, now happen in days, if not hours.
  
  Once the bottom is reached, the Sensex will start its upward momentum soon enough. Investors should sit tight, and start investing through systematic investment plans.
  
  
  
  
  

 

[magudi]

Anyone up for some structural reforms ?