Wednesday, March 18, 2009

'Brace for 10 years of insipid global growth'

Venkatesan Vembu
Monday, March 16, 2009 3:34 IST
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In early 2007, when the world was awash in liquidity and asset prices were soaring worldwide, economist Jim Walker warned of a "coming Apocalypse". In the two years since, the global economic plot has unravelled pretty much as Walker prophesied. And even today, Walker's outlook on the global economy -- and his assessment of the policy responses worldwide -- is grim. In this second and concluding part of an interview to DNA in Hong Kong (the first part appeared in Thursday, March 12 edition), the founder of Asianomics warns of prolonged economic agony. Excerpts:

Are we now anywhere near the end of the unravelling of the apocalyptic scenario you outlined two years ago?
The 'end of the beginning' would be a better characterisation than 'end'. We now know that there is a crisis, and we're also aware of the nature of it. The question is what governments will do about it. There's a danger that we'll elongate the potential recovery. We've seen that in Japan over the past 20 years; various policy mistakes have led to the Japanese economy being basically in recession for nearly two decades. Although there was a recovery, the Japanese people don't sense it.

Western governments are making a lot of the same mistakes: they seem unwilling to recognise what the problem is. The real problem is that there was a tidal wave of credit and money that came into the real economy via the financial system, which distorted the industrial sector -- not just in the US and Europe but in China, in particular. When the realisation comes that that was an unsustainable structure, it has to correct itself; there has to be a consolidation; there has to be a move away from some of the old spending patterns towards new savings patterns. And, thereafter, the economy can start getting up and running again. But unfortunately, a lot of the governments' efforts are in maintaining that old industrial structure that cannot be sustained.

So, we're potentially going down a route where, instead of a one- or two-year recession -- even if it's a deeper, nastier and painful recession -- we could end up with something like 5 to 10 years of very insipid growth in the global economy.

The subprime mortgage contagion seeped through the entire financial system. Are there any more shocks we've not yet uncovered?
It actually spread quite rapidly from subprime to every aspect of the financial system. However, it has taken slightly longer on a geographical basis to be clear where it's going; if you remember, even a year ago, the flavour of the day was 'decoupling' (the theory that Asian economies would be insulated from a slowdown in major developed economies); that was never likely but people didn't recognise it. After the US and western Europe, export-led countries in Asia, including Japan, were in trouble. Now eastern Europe is in deep trouble. But people are still very sanguine about China. And that's probably going to be the next phase, where people realise that China has problems as well.

And along with China, commodity-exporting countries will be very adversely affected. So, most of the problems are relatively clear; now there are still elements of hope that are going to be dashed.

Is there anything else that could come out from unexpected places? Insurance companies are probably the next big problem area in the financial system, because they have so much of the unwanted paper and their capital base is shaky. Local municipal governments in the US will start defaulting on bonds because their revenue streams are based on property. We've not even begun to see credit card defaults in a dramatic way, but with rising unemployment that could come up. Commercial property is another area. These are probably 'known problems' that are going to become more intense.

What are the unknown 'unknowns'?
At the moment, I think we've uncovered most of the rot. The biggest one out there is that people just haven't quite understood the effect of the credit tsunami on places like China, and what it has done to the Chinese industrial structure, the malinvestment there.

Can the crisis in eastern Europe blow up?
Things are pretty bad in eastern Europe. Actually, it was quite easy to spot how bad it was there. The IMF was putting together a table a couple of years ago in the light of the 1997 Asian crisis. It looked at things like current account deficit, credit growth, credit growth relative to GDP growth, and the local banking system's liabilities with foreign banks, particularly the big western banks.

All of these indicators are kind of standard matrix for flagging potential problems. Eastern Europe at the beginning of this crisis looked much more imbalanced than Asia did in 1997. All the 'flags' signalled there was a major problem. A lot of currencies in eastern Europe have fallen sharply -- not just against the dollar but against the euro, which was their base currency. There hasn't been sufficient appreciation of the crisis in eastern Europe -- probably because there were crises everywhere. But there's going to be a much more severe disruption -- possibly even social and political instability -- over the summer in eastern Europe.It's winter now, and spring and summer are when you see political and social activity. It's going to be a long, hot summer for many governments in eastern Europe.

Are you inspired by the policy response of the Obama administration and other western governments?
I'm not inspired at all; in fact, I'm quite distraught. For example, the central banks moving very swiftly towards a zero interest rate policy...

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China's Economic Growth Could Evaporate, Says Pundit

Migrant workers wait for employers on a street in Chengdu, Sichuan province, on February 2, when Beijing announced about 20 million migrant workers have lost their jobs because of the economic downturn
Migrant workers wait for employers on a street in Chengdu, Sichuan province, on February 2, when Beijing announced about 20 million migrant workers have lost their jobs because of the economic downturn

At a time of nearly universal dismay over the business outlook, there are few experts anywhere who can out-gloom Jim Walker, an economist at an independent Hong Kong research firm called Asianomics. In his thick Scottish accent, Walker predicts the worst global recession since the Great Depression. GDP in the U.S., he says, could contract as much as 5% in 2009, and Europe by 2%. He is no more bullish about the economies in his area of specialty: Asia, a region where most of his colleagues foresee more buoyancy. China won't see GDP rise more than 4% in 2009, he says, and the country's economy may not grow at all. "There is going to be precious little growth anywhere," Walker says.

Before writing off Walker as just another member of a growing Greek chorus of dispirited prognosticators, consider that he has a history of detecting worst-case scenarios before they came to pass. Back in 1995, Walker, then an economist at brokerage house CLSA, penned a report entitled It's Life, Jim, but Not as We Know It: Asia Decoupling, in which he and his team of economists warned that Asian currency regimes, if not reformed, could be susceptible to Mexico-style meltdowns in two to three years. Two years later, the region plunged into the 1997 Asian crisis, which was triggered by the rapid decline of currencies such as the Thai baht.

In this current downturn as well, Walker's dim views, which at first seemed on the fringe, now appear less farfetched. The International Monetary Fund (IMF) in late January revised its forecasts for 2009 sharply downward, predicting the slowest global growth rate since World War II, at only 0.5%. IMF chief economist Olivier Blanchard said he expects "the global economy to come to a virtual halt." Even China would record only 6.75% GDP growth in 2009, according to the IMF.

Walker has been arguing for months that China was in trouble. As the U.S., Europe and Japan suffer through a recession in 2009, Walker expects Chinese exports to contract. In a sign of how much damage the global slowdown is causing in China, the government this week estimated that 20 million migrant laborers have lost their jobs. But just as important to Chinese growth is private investment. Corporate profitability in China was deteriorating even before the worst of the global financial crisis hit, and that will soften investment, which makes up more than 40% of GDP. In the first 11 months of 2008, profits at 350,000 enterprises in China grew a mere 4.9%, down from 37% in the same period in 2007. "We're already seeing a huge swing in the fortunes of Chinese companies," Walker says. "When people see a very different investment environment, they actually cut their investment. That's the real danger China is facing at the moment."

Other economists believe China's massive stimulus plan will keep growth at a high level despite the global downturn. In November, Beijing announced a $586 billion package, much of it new spending on infrastructure. Wen Jiabao, China's premier, said recently that he expects China to meet its 8% growth target for 2009. Walker, however, is much more skeptical about the government's ability to rescue the economy. "What the government has to contend with is a slowdown in every other sector of the economy," he says. Since the Chinese government accounts for only some 20% of GDP, "how it will make up for a slowdown in the other 80% is beyond me."

The China crunch will have repercussions for the rest of the region and the world. The hope among other economists was that trade within Asia, with a stable China at its core, could spare exporters such as Taiwan and South Korea from the worst of the recession in the West. That hope, Walker argues, has evaporated. A major downturn in China "takes the floor away" from growth in the rest of Asia, he says, leaving the region more exposed to the woes of the U.S. and Europe. Most vulnerable are Asia's smaller, trade-dependent economies. He forecasts Taiwan and Singapore could see GDP sink by 5% to 10% in 2009, while Korea's economy could contract by as much as 5%. "We're still in the very early stages of the downturn in Asia," Walker warns.

There are some bright spots. Walker is relatively bullish on India, which he believes could growth 3% to 5% in 2009, possibly making it the world's fastest-growing economy. The reason, he says, is India isn't as exposed to the global downturn as China. "India has not been growing in the past decade because of excess world growth," Walker says. "Domestic demand is the strong component." He also argues that Asia could take the lead in a global recovery, and might show signs of an upturn by early 2010. The turnaround will be sparked by Asian companies, which generally are in healthy shape. "They are much less leveraged" than in the past, Walker says. "There has been an aversion to taking on debt in Asia since 1998. There is less vulnerability to a downturn in economic activity." As interest rates around the region fall, Asian companies will begin to seek loans and invest, jumpstarting regional growth. "In that sense, the region is in actually quite a good position to springboard back into recovery" ahead of the U.S. or Europe, Walker says.

Still, Walker worries that the pain caused by this global crisis will lead to "a de-globalization move" over the next two years by Asian governments. Countries looking to preserve their own economies could become less eager to promote global trade, he says, and could resort to protectionism as competition for export markets becomes cutthroat. There will be "much more introspection, especially in emerging markets, about joining the party with as much gusto as in the past," Walker says. "There is going to be a lot of questioning about capital market opening. The old model is broken and they don't know what to replace it with."