Ruchir Sharma of Morgan Stanley has warned of a global recession, driven by collapsing growth in China. World growth is dropping well below IMF predictions, with emerging markets performing especially badly.
Currency after currency is falling against the dollar. The Brazilian real is down over 23% since the start of the year. The Russian rouble has lost more than half its value since 2013. This raises fears that more than simply market forces are at work. It suggests that competitive devaluation may have begun, with countries manipulating their currencies downward to curb imports and promote exports. Such competition must be stalled. It will be a race to the bottom that exacerbates the impact of slowing Chinese growth, and ensures a truly deep recession.
The Great Recession of 2008 led to a huge plunge in economic growth everywhere. Yet, countries resisted the temptation to go for competitive devaluations or big import duties to protect their economies. Economic history had taught them that the Great Depression of the 1930s became much greater thanks to competitive devaluations. In that era, country after country raised import tariffs and cut currency rates in an effort to expand exports and cut imports.
But when every country reduced its imports, this had the unanticipated effect of reducing world exports too. Globally, exports and imports must be equal, so reducing imports meant reducing exports too, and, hence, all economic activity. Thus, competitive devaluations and high tariffs drove economies further and further down in a vicious spiral.
The rupee is down only 3.4% since January to Rs 65.26. But the exchange rate was Rs 45 per dollar in 2011, Rs 55 in mid-2013, and Rs 59 when Narendra Modi was elected in 2014. Since then, the rupee is down 10%, but exports have fallen eight months running. Some economists claim the rupee was overvalued and has now returned to saner levels. The accompanying graphic shows that, even after the latest dip, the rupee has fallen much less than other emerging market currencies since January. What appears to be competitive devaluation is, in part, appreciation of the US dollar against almost all other currencies.
Breaking Family China
One exception till recently was the Chinese yuan. But last week, China too devalued by 3%, and some experts fear it will dip fully 10% in coming months. They fear China is aiming again for export-led growth to revive its flagging economy. China claims to be on target for 7% GDP growth.
But analysts watching trends like electricity consumption, manufacturing orders and railway freight say that true growth may dip to just 5%. This, they feel, has sparked panic in the Communist Party, which views rapid growth as essential for not just economic but political stability.
President Xi Jinping started his term with the assumption that the export-led model that gave China record-breaking growth in the 1990s and 2000s was unsustainable, given the larger size of its economy today, and limited capacity of other countries to absorb Chinese exports at the same hectic pace. Xi aimed at rebalanced growth, focusing more on domestic demand than exports.
He provided massive loans to finance infrastructure and construction, and, more recently, the stock market too. However, instead of aiding real growth, this mass infusion of debt has created huge bubbles in the property and stock markets. These are unsustainable and look like bursting.
The government’s attempt to prop up the stock market failed. The market could plunge much deeper. And so, pessimists fear, Jinping has decided that the rebalancing approach has reached its limits, and must now be buttressed by a return to export-led growth. Huge industrial capacities in the country lie idle while companies bleed. So, a new export push — aided by a falling yuan —could provide an alternative source of growth for at least a year or two. But others will devalue even more to keep their edge.
Earlier, China kept the yuan fairly stable against the dollar, partly to get IMF nod for the yuan’s inclusion in the Special Drawing Rights basket and partly to establish itself as the world’s next reserve currency. But a strong dollar has pulled the yuan up too, hurting exports. Optimists hope the recent yuan devaluation is a oneoff event. But pessimists fear China will continue to depress its currency to flood the world with exports.
Dieting Bad for Rupee
Some Indian analysts want steep rupee devaluation. But studies by C Rangarajan, Prachi Mishra, Sajjid Chinoy and Jehangir Aziz suggest that Indian export growth is not strongly linked to the exchange rate, and depends much more on global growth.
So, steep devaluation may not revive Indian exports, given gloomy global trends. Real rupee appreciation should be avoided. But a more aggressive approach than that could simply fuel a currency race to the bottom. That is a bigger danger by far. India needs to sound alarm bells on this, and get the IMF on board to stop any currency war. Slowing Chinese growth alone may not cause a world recession. But competitive devaluation surely will.