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Ethos Issue 6, Jul 2009
It’s Not Over Yet
Manu Bhaskaran
A quick and painless recovery is unlikely, as delayed effects
of the economic crisis have yet to kick in.
There is now growing optimism
about economic prospects. We
have seen economic news
improving in recent weeks, not just in
the US but in China and other parts of
Asia as well. This has been complemented
by signs that governments are making
headway in getting their financial sectors
back on track. In the US, “stress tests”
have been carried out and produced
results that were better than expected,
implying that most major banks in the
country can return to solvency with a
manageable amount of capital raising.
All this good news has sparked off a
sizeable rebound in global equities.
The question is—how sustainable are
these improvements in the global
economy and their subsequent stock
market rallies?
UNDERLYING ECONOMIC CONDITIONS REMAIN FRAGILE
Despite some definite progress, my view
is that there is still a lot more bad news
to come.
First, the best economic lead
indicators we have—those that predict
what will happen to global economic
activity in six to nine months—tell us
that output will continue to fall for
some time more. The Organisation for
Economic Cooperation and Development
has composite lead indicators for all
the major economies of the world.
Significantly, their indicators point to
high risks of further downside for all the
countries they look at, including China.
Second, the financial sectors of
major economies such as the US and
Europe remain in a parlous condition.
Even with the gradual recovery in credit
markets, financial sectors remain some
distance away from re-starting their
critical function of providing capital and
liquidity on a sufficient scale to support
economic growth. Vital parts of the
financial resolution—re-capitalisation of
the banking sector and disposal of bad
assets—are progressing but only slowly.
Third, if economic activity is going to
continue to fall and if financial sectors have not returned to strength, then we
are likely to see more financial stresses.
As unemployment continues to rise in
major economies and as cash flows in
the business sector remain constrained,
bad debts must rise. In the US, the
outlook for commercial real estate
looks particularly bad. The International
Monetary Fund (IMF) has estimated that
the global crisis will induce financial
sector losses of US$4.05 trillion in the
US, Europe and Japan, of which only
about a third has been recognised. Of
this extraordinarily large amount,
US$2.7 trillion of losses are expected
to be in the US alone, although some
economists are estimating US losses
at US$3.6 trillion. The scale of these
likely losses throws some cold water on
the optimistic findings of the US bank
“stress tests”, suggesting that more
financial stresses are likely as we move
to the end of this year.
IMPLICATIONS FOR ASIA
In essence, the global recession is
unfolding in such a way as to produce
more shocks which could hurt Asia. One
area of concern is the emerging markets
in Europe and the Middle East. Several
countries in the Baltic region as well as
south-eastern Europe are on the brink
of a crisis. While timely intervention
from the European Union and the IMF
will probably help prevent a crisis on
the scale of the Asian financial crisis, we
are likely to see considerable financial
stress in these economies. Since
western European banks have been
the major lenders to these economies,
there will also be knock-on effects
on the more developed countries of
Europe. If emerging market risks rise,
investors will become warier of Asian
emerging markets as well, even if their
fundamentals are better.
In addition, we should also expect
delayed effects on the rest of the world,
especially in developing countries. For
instance:
• As the recession spreads, major
importers of foreign workers such
as Dubai, Taiwan and Malaysia are
cutting back on visas for foreign
workers. Consequently, remittances
sent to families in countries such
as India, Pakistan, the Philippines,
Indonesia and Bangladesh are likely
to fall in the later part of 2009. For
Bangladesh and the Philippines, the
consequences could be very worrying
since remittances support around
10% of GDP.
• Another example of a lagged effect
is the impact of falling commodity
prices. Currently, many rural
households have not cut back
their spending very much because
they still have savings from the
commodity boom to live off, but this
buffer is eroding quickly.
• Another example would be the effect
of corporate sector adjustments
to the slowdown—hotel and tour
operators are cutting prices and
so are pressing their workers and
suppliers to cut wages and prices as
well. In manufacturing, workers are
being laid off; in China, Thailand,
Indonesia and other countries where
rural-urban migration is substantial,
remittances from urban migrants to
their families in the rural areas are
likely to fall, causing rural demand
to slow.
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