16 Feb 2016 18:44 IST

What is happening to the global economy?

The Bank of Japan headquarters, Tokyo. Contrary to the time honoured practice of paying interest to its customers, central banks of Switzerland, Sweden and Japan charge commercial and depository banks negative interest rates. (Reuters)

The economic landscape is fragile and there are many reasons for it

Switzerland, Sweden and Japan could not be more different in their country profiles but there’s something common that they now all share. Their respective central banks charge commercial and depository banks negative interest rates. If you are a bank, it means that you pay these central banks to hold your money rather than the time honoured practice of getting paid for entrusting them with your funds.

The central banks of Bulgaria, Czech Republic, Denmark and the European Central Bank look extremely generous by comparison because their interest rates are positive. Not too positive, though. The rates are a miserly 0.01 per cent for Bulgaria to 0.05 per cent for the Euro Zone. Note the decimal point here. The Bulgarian rate is one hundredth of 1 per cent. A rounding error to zero is what it really is.

The US Federal Reserve Bank had kept its interest rates pegged at zero for seven years — the longest in history — before hiking them to a whopping 0.25 per cent in December 2015. Testifying before Congress this week it seemed as though Janet Yellen, the Fed Chair, was already having second thoughts about her decision two months ago, saying, “There’s a chance of a downturn (recession) ahead.”

Asked if the Fed could go negative, she cautiously replied in Fed-speak: “In light of the experience of European countries and others that have gone to negative rates, we’re taking a look at them again, because we would want to be prepared in the event that we would need (to increase) accommodation.” In other words, the US could well join Japan sometime in the near future. Oh, well.

Off track

Never before in my 30 plus years of watching international markets have I seen the global economy this fragile. Economists cite many reasons and it is hard to pinpoint the cause. This actually makes the problem harder. Just one of these reasons is normally enough to derail economic growth but when there are multiple factors, the train is likely to be off the track for some time yet.

Throughout modern history, one or two regions have borne the burden of helping the world chug along. After World War II, massive reconstruction efforts in Europe and Japan fueled the world economy for a long time. During the cold war, the defence build-up in the US and the former USSR had world economies doing well. During the socially volatile 1960’s and beyond, West Asian countries were flush with oil money and as they both spent and invested, there was hope.

Pause for effect?

Today, every nation that was a rock star at one time or another is tame and dormant, like a wild animal that has just completed a heavy meal. Europe, already struggling from loan excesses of the PIGS (Portugal, Ireland, Greece and Spain) countries had to contend with a million refugees from the Syrian war. Japan is back in a recession, for the sixth or seventh time in the last 20 years. Its lost decade of the 1990’s extended to a second decade (the 2000’s) and is on poise for another.

The price of oil has fallen so much that all the OPEC nations, including Russia, are deeply hurting. Eighty per cent of Saudi Arabia’s government budget is reliant on oil revenues, and it had planned domestic spending assuming that oil would be at $110 a barrel. At $35 a barrel, Saudi Arabia has had to spend down its dollar reserves just to keep the population happy. The country cannot risk an uprising as during the Arab spring. How long can it keep doing this? Oil prices are not likely to rise anytime soon.

When oil economies don’t have money, they can’t buy from export giants like Japan and China, causing those economies to slow down. As the world’s factory, China’s massive exports meant that it had to keep building to stay competitive. Not too long ago, China was consuming more than half of all of the world’s steel, minerals and aluminium. Today, China’s growth is still an impressive 6.9 per cent but given that the world was addicted to 10 per cent year over year growth, 6.9 per cent seems pale. In economics, it is all about comparisons.

In a blog post, Volatility is here to stay: What you can do about it, Tim Buckley, the Chief Investment Officer at Vanguard, one of the world’s largest mutual fund companies, summarised it well: “We just came off a long stretch of remarkably tame markets, so the sudden surge in volatility is going to feel worse than it actually is.”

India – Rising Star

India is now the sole hero growing at a 7.9 per cent clip, inviting envy from around the world. The country is exceptional because it is not dependent upon exports as China is. It is also the polar opposite of China as far as the role of government is considered. As I point out in a recent article The Hindu BusinessLine , the Indian economy is barging ahead not because of the government but despite its presence.

This is the time for the Indian government to invest in infrastructure, sell off under-performing government assets and bring down its deficits. But if the BJP resorts to massive public spending for social programmes — for votes — by exploiting savings in its oil import bill, India’s growth will stall. Remember that once you start a social programme, it is very difficult to suspend or end it.

At US President Ronald Reagan’s First Inaugural address, Reagan declared: “Government is not the solution to our problem; government is the problem.” The US economy expanded the fastest during Reagan’s eight years in office. Let us wait and see if Arun Jaitley adopts the Reagan doctrine and stays out of the way of a booming Indian economic miracle.

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