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Economic notes

July 30, 2019

Global developments

Opinion

July 30, 2019

The world economy is facing a variety of threats. For one, its growth is subdued. Inflation is well below the historical trend. International trade continues to decline not just because of the tariff war but also the looming dangers from Brexit, recession in the Euro-zone, and broader security issues.

Last week, the IMF has downward its world growth outlook for 2019 compared to last April. Latin America (led by Brazil, Mexico and Argentina), Sub-Saharan Africa, Middle East, Afghanistan and Pakistan and Asia and the emerging market have all contributed in some measure to this weak outlook. Trade volume growth fell to around 0.5 percent year-over-year in the first quarter and likely worsened in the second. This is seeping into a manufacturing slow-down in two out of three major economies, China and Euro-zone, while it is barely positive in the US.

Major threats are emerging from the overheating of the US economy and an imminent slow-down in China. The US economy has witnessed the longest economic expansion – growth without recession – for a record ten years and is still continuing. The Q1 growth of 3.1 percent just slowed down to 2.1 percent in Q2 but is still slated at 1.9 percent for the year. Unemployment is lowest in 50 years and inflation is close to the Federal Reserve’s target of 2 percent.

Since his appointment in February 2018 as Fed chairman, Jerome Powell raised interest rates four times in 2018. This infuriated President Trump who started tweeting out scathing criticism of the chairman. Last December, the chairman signalled a policy reversal. There were many voices that believed the Fed was going overboard in slowing down the economy for fears of overheating while there was considerable room for expansion. The emerging market economies at the time had also reacted negatively as a stronger dollar led to a significant turmoil in local currencies. But these voices also argued that the threat to economic expansion was coming from Trump’s own policy of declaring trade on China, which is going to be the leading cause of global slow-down.

However, since then the Fed is looking for ways to continue to follow an accommodative policy. More recently, in his bi-annual briefing to Congress, the chairman has signalled that there may be room for further rate cuts. He argued that heightened uncertainties because of weakness in growth outlook in other major economies and trade dispute are reasons to protect expansion at home. Even before the actual rate cut, the market reacted enthusiastically and leading indices made significant gains soon after his remarks. It seemed that Powell has already delivered what the market had hoped. BBC in a report said “the financial markets are indicating that the Fed at its 31 July meeting will cut interest rates by 25 basis points, although some analysts have seen the possibility of a larger cut.”

Analysts say the Fed policy is contributing to unsustainable increase in all types of assets from housing to stocks, gold and others. Scott Minerd, an investment banker, wrote in Barron’s magazine: “While the Fed has more than succeeded in stabilizing markets, the ensuing liquidity-driven rally in various markets has boosted asset prices, including stocks, bonds, precious metals, energy, and even crypto-currencies. In an economy that is already at a full employment, stimulus through an easy monetary policy would only go to create bubbles which would burst as soon as a shock arrives. The slow-down in consumer spending is one such shock.”

He went on to warn: “The Fed’s current policy of anticipatory and preemptive rate cuts likely will lead to unsustainably high asset prices and increased financial instability. This can only make the next downturn worse. If the US continues down the current policy path, we will find out that the Fed’s cure for avoiding a near-term recession and negative interest rates may ultimately make the disease worse.”

The Chinese economy, on the other hand, is showing signs of a major slow-down in nearly three decades. The new data on growth showed that the economy had slowed from its annual growth rate of 6.4 percent to 6.2 percent in Q2, its slowest rate since 1992. In a curious development, President Trump has taken this as a sign of the success of his protectionist policy. He tweeted: “China’s 2nd Quarter growth is the slowest it has been in more than 27 years. The United States Tariffs are having a major effect on companies wanting to leave China for non-tariffed countries.

“Thousands of companies are

leaving. This is why China wants to make a deal with the US, and wishes it had not broken the original deal in

the first place.

“In the meantime, we are receiving billions of Dollars in Tariffs from China, with possibly much more to come. These Tariffs are paid for by China devaluing & pumping, not by the US taxpayer!”

In a recent report, Reuters has indicated that industrial profitability is on the decline, leading to delays and cancellation of investment plans by manufacturers. In the backdrop of the trade war with the US, this is reflective of a deeper malaise that would lead to a slow-down of the main engine of economic growth in Asia.

In Pakistan, do we have lessens to learn from these developments? There are several. First, the global slow-down means that our exports could remain dormant for a longer period than anticipated. Last year, there was a negative growth of about 2 percent in our exports. Second, there is a widespread slow-down in the domestic economy with production of major industries showing a decline of 3.8 percent during Jul-May compared to the same period last year. Third, the flow of credit to the private sector was also down during the last fiscal year compared to the previous year. Fourth, the excessive increase in interest rates has left little room for future investments as the cost has increased steeply to unprecedented levels.

Finally, there are rising concerns whether we have signed on an IMF programme that is too restrictive of growth from the very outset and has over-estimated the extent to which the aggregate demand needed to be curtailed for stabilization. It is time these matters are pondered upon so that there is resurgence in a fast-slowing economy.

The writer is a former finance secretary. Email: [email protected]

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