Monday, March 27, 2006

'The real threat is global imbalance'

The Rediff Interview/David Wyss, chief economist, S&P

'The real threat is global imbalance'Sunil Jain March 24, 2006

Standard & Poor's Chief Economist David Wyss predicts that 2007 will be a reasonably good year as well (4 per cent global growth as compared to 4.5 this year), but sees increasing global imbalances as the problem area.

Excerpts from a conversation with Business Standard:

Despite the risks associated with the twin US deficits, you're projecting pretty robust growth in not just this year, but also in 2007.

We're looking at 4.5 per cent this year and 4 per cent in 2007. The Eurozone is looking better and the good thing about Japan's growth (this is the third year it's over two per cent) is that it is now driven by domestic demand and not exports as in the past. Asia and Latin America continue to do well and account for half the world's growth.

The twin deficit is not just a US problem. France, Germany and the UK have sizeable fiscal deficits as well, roughly the same size in relation to GDP. The US trade deficit has to be seen in the context of a sizeable trade surplus in Japan and Asia.

So the issue is of poor spending in the rest of the world?

It's a real problem. The Eurozone accounted for 15 per cent of the world's GDP in 2004, but just 6 per cent of the world's growth. Japan accounted for 7 per cent of GDP but just 4 per cent of growth -- so, the two areas account for around a fourth of GDP but just a tenth of growth. This is the problem, and since they account for most of US exports, the problem gets heightened.

With poor productivity growth in the EU and Japan (it's around 1 per cent in both areas as compared to 2.5 in the US) and no population growth, few people want to invest here either. So, the overhang keeps getting worse.

People focus on China's mercantilist policy and the currency peg that is clearly artificial and aimed at keeping trade going (I think the remninbi's about 20 per cent out of whack), but Japan's got a larger trade surplus -- I think the yen should be around 95 or so to the dollar, instead of the 116 or so that it is today.

The S&P 500 are also sitting on piles of cash -- the problem is not so much a glut of savings as it is a dearth of investment.

With the dollar getting stronger, the problem's getting worse. So when does the dollar start weakening?

The Fed will probably have two more hikes by May and stop around 5 per cent, while the European Central Bank will move to 3 per cent by the end of June after two more hikes. Only when the Fed stops its tightening, will people wake up to the exchange risk, so the inflows to the US should slow down (this will then increase bond yields) and the dollar will soften. The problem is that while markets usually fix things by currency depreciation/appreciation, I see the Bank of Japan going back to playing an active role instead of letting the market function.

So you're seeing a soft landing? What about the Chinese moving to euros, and what of the property bubble bursting in the US?

I'm seeing a soft landing, yes. I don't see the Chinese moving to the euro in a big enough way since this will hit them a lot more than it will hit the US. The property bubble will burst, but I don't see it bursting in the sense of property prices falling -- I see it bursting as in prices not rising. Of course, there will be pockets where you'll see actual declines.
Few people agree with this scenario. Aren't people taking double mortgages in the US, and so won't consumer spending take a huge fall once interest rates rise and prick the bubble?

Most US mortgage rates are fixed-interest and not floating, so even if rates rise, the immediate pressure will be restricted. The point of being over-leveraged is also over-stated. On an average, the mortgage value to the value of a house is around 45 per cent, which is safe. The US is actually not as high-debt as compared to the EU or Japan.

To what levels do oil prices need to climb to, before we see an impact on global growth?

Well, in real terms, we're seeing the highest oil prices in the past two decades. But the reason why it's not biting so far is that the share of energy in US GDP is around 7 per cent today as compared to 14 per cent in 1980 -- so we're a lot less energy-intensive. Plus there's more head room due to the enormous deflation brought about because of China and India in areas such as textiles (costs have gone down 4-5 per cent per annum here), and food's been pretty flat as well.

I don't think there's this cliff for prices to breach, but I think it could even go to $100 before we see a real problem. But the real issue here is how things unfold. If oil prices continue to rise due to demand, that's self-correcting since if prices start hitting demand, they'll self-correct.

A supply-side shock, however, is a different matter altogether. Over the next three to five years, however, there's a lot more capacity coming up (Canadian tarsand, coal liquefaction and Qatar's even putting up a plant to convert natural gas to diesel) and so prices should come down.

Can both India and China sustain their growth?

I think the weakness of the banking system in China can be tackled by recapitalisation, but the economy's now becoming too big to be led by exports and investment levels are already up to around 50 per cent.

India's growth is lead by tech and that can't go on because there's just so many engineers and software people you can produce -- don't forget, it takes 22 years to turn out a college graduate! India will keep to a 7-8 per cent growth and China will slow a bit, though it will still be more than 9 per cent.

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