29 Jun 2010, 0920 hrs IST,Aditya Puri,
The world has changed structurally. On the ground, change will require time but the decoupling of the East & West has begun. The financial markets, however, are slow learners, creatures of habit, and therefore, create confusion in the short-term or transition (defined as volatility) period.
Basically, flight to safety still means gold and US dollar. However, we must understand that unless they invest these dollars in the US equity market or actively trade treasuries, there is very little return and the money would have to be returned or invested in growing GDP markets.
Also, the rating agencies (as usual) are behind time, resulting in rating bearing little co-relation to reality which distorts cost of credit. We only need to examine accepted facts to understand where the world is going.
Growth Rate
The forecast GDP growth rate during the next 3-5 years for the following countries are (%):
- US: 1.8;
- Europe: 0.8;
- East Asia: 8;
- China: 8.5;
- India: 8.
This reflects the level of structural adjustments required in the Western countries in terms of asset bubbles, financial contagion, stimulus, exchange rate, etc.
A high GDP growth rate on the other hand indicates that these countries were not structurally affected by the crisis. It also provides the countries with flexibility and time in addressing their problems.
Composition of Trade Between Countries
An examination of the growth/change between regional blocks is illuminating. Basically, the US and Europe, while important, are rapidly reducing as % of total trade while Middle East, Asian and African trade is increasing and also being focused upon strategically India-China trade has grown and will continue to grow exponentially. Political equations will be subject to economic reality.
Asia’s contribution to global merchandise trade has been increasing steadily over the years. In fact, Asia is the second-highest contributor to total global trade flows behind Europe. On the exports front, the Asian region has become the primary exporter to the advanced economies, especially the US region in the pre-crisis period.
However, imports have also started to pick up over the last few years as the Asian region (particularly China) is trying to change its economic structure from being export dependent to consumption driven. Overall, the contribution of Asian trade to total global trade has risen from 18.8% in 1983 to 24.8% in 1993 to 27% in 2008.
Africa’s trade with the rest of the world is also increasing though more moderately than in Asia. Africa’s share increased from 2.6% in 1993 to 3.2% mark in 2008.
There are important changes taking place within China as well. Growth is becoming less dependent on exports and more on internal demand.
Europe’s Govt sector a drag for years to come
The consolidated budget deficit or net borrowings for the eurozone in 2010 is likely to be close to 7% of its GDP. Even in the best case scenario, the net borrowing for the region is likely to remain over 4.5% in 2015. To put this in perspective, the ratio was just 1.2% in 2006. Also, government spending averaged 50% GDP and will not be anywhere close going forward, with resultant impact on the GDP.
Currency and Commodities
Currency and commodity markets will drive Asia’s growth momentum. Strong GDP growth both in China and India will power the demand for commodities. Structural bottlenecks in supply for a whole range of commodities from agricultural to mineral oil mean that prices in the long term are headed northward.
Besides, investors seeking higher returns on their investment will flock to Asia; this will result in a flood of capital and Asian currencies will see a phase of secular rise against their G-7 counterparts. This could erode export competitiveness, and economies within Asia such as India and Indonesia that are more internally focused, will outperform the others.
Unemployment
Employment is known to lag economic recovery and even if the growth cycle were to turn in the US and parts of Europe, it might take 2-3 years for the unemployment rate to go significantly below the current levels of close to 9%. Economies on the periphery of Europe such as Spain, with unemployment of around 25%, have seen permanent damage to their growth model and that will be difficult to repair.
Currency
In the short term, the uncertainty surrounding Europe, the possibility of deflation in China’s housing bubble will see a sustained search for safety. Old habits die hard and despite the US economy’s myriad problems, US treasury bonds remain the preferred safe haven for investors.
Thus, unless sentiment improves significantly and risk-appetite returns, the bid for the dollar will continue. In the longer term, however, America’s structural imbalances (particularly its fiscal overstretch) will catch with the dollar.
Since Europe and the UK find themselves in worse straits, much of the depreciation in the dollar will be vis-à-vis the Asian currencies and not the euro or the pound. The euro will survive but remain sickly in the foreseeable future.
India is destined for big things!!!. The real world is moving and the financial world will recognise events with a Lag.
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