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Recovery on but still a long way to go

— PHOTO: AP

UNWINDING GLOBAL IMBALANCES: Federal Reserve Chairman Ben Bernanke (right) chats with European Central Bank President Jean-Claude Trichet (centre), and Bank of Japan Governor Masaaki Shirakawa, with the Teton Mountains and Grand Teton Peak in the background, during the annual conference of the Federal Reserve in Jackson, Wyoming (U.S.).

Until recently almost all forecasts for the global economy tended to be highly pessimistic. Professional forecasters — the list includes global institutions such as the International Monetary Fund, the World Bank and the Word Trade Organisation — were probably being overcautious lest they should be faulted for ignoring the plethora of bad news that seemed to be coming in one unending stream, especially from the developed world.

The IMF’s forecast of the world economy going into a decline in 2009, on the back of sharp contractions of the developed economies had remained valid since late 2008. A few developing ones, especially India and China, were expected to post positive growth which, however, was not sufficient to fully offset the decline in the developed world. Forecasts from other global institutions were gloomier.

For instance, as recently as in June the World Bank in its Global Development Finance Report had forecast the global output to decline more sharply in 2009 than it had anticipated. By that time, however, better news leading to more upbeat forecasts had started coming in. The IMF was already predicting a pull out from recession.

China posted a robust 7.9 per cent GDP growth in the second quarter. Data from the U.S., though far from normal, were suddenly looking upbeat. Its employment figures, while still a cause for serious concern, had stopped deteriorating further. The financial system has stabilised. Many leading banks that took public money during the worst phase of the crisis have since paid back. In many other ways too the outlook has brightened.

Elsewhere, the two major European economies, Germany and France, have come out of the recession, according to official statistics. The world’s second largest economy Japan also reported output growth in the second quarter.

The consensus of opinions suggests that recovery has started but its contours are still hazy. Moreover, it has to be sustained through a combination of policy measures and international co-operation. Looking ahead, the world economy may not go back to its ‘normal’ (pre-crisis) state for the next two to three years. Elaborating that theme, the IMF in a very recent report says that substantial “rebalancing” acts will have to be undertaken to sustain the recovery. For one, policy measures should aim at replacing public spending with private demand.

To combat the crisis strong fiscal responses are necessary. Private demand is weak and in many countries non-existent. However, countries around the world are realising that fiscal stimuli of the type undertaken cannot be continued indefinitely. But how soon they can be phased out still remains a debatable point. An influential gathering of central bankers meeting in Jackson Hole, Wyoming (U.S.) have pointed out that it is not safe to blithely assume that recovery is under way: policy must remain stimulative in the foreseeable future.

Second, there must be a rebalancing of demand across countries. The U.S. was not only at the centre of the crisis, but also is crucial to world recovery. There has to be a shift from domestic to foreign demand in the U.S. and a reverse shift from foreign to domestic demand in the rest of the world, especially China. These suggest that exports from the U.S. must increase, thereby reducing its current account deficit simultaneously with China and other Asian countries. While it may be in the interests of China and other countries with large surpluses to go along with the prescription recommended by the IMF, putting those ideas into practice will not be easy. Unwinding global imbalances — the surpluses from Asia financing the deficits of the U.S. — was a priority area even before the crisis. An orderly way of doing this was what policy makers were hoping for. The crisis and its aftermath show how difficult it would be to implement a solution, never mind its universal acceptance.

Normal recessions admit of some well tried out solutions that invariably turn things around predictably. The current recession is far from normal. The turnaround will not be simple.

More normal recessions can be countered by conventional monetary and fiscal measures. According to the IMF, the crisis has left deep scars which will affect both supply and demand for many years to come. On the supply side, in many advanced countries, the financial system has become dysfunctional and will take some time to go back to its previous state. Financial intermediation, the process of allocating resources, will be impaired.

Emerging markets will witness a paucity of capital inflows.

Of the demand side, factors having a bearing on growth and employment will remain crucial for some more years. Second, all the positive forecasts of growth are predicated on a combination of fiscal stimulus by government and inventory rebuilding by firms.

At some point fiscal stimulus will be phased out. Inventory restocking will also come to an end. Hence the importance of continuing with the extraordinary measures.

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