Boom or recession? Fifty-fifty

The new year 2005 has opened on a note of high optimism. The Sensex has hit a record 6680, and the CSO has estimated GDP growth in the July-September quarter at 6.6%, following 7.4% in the preceding quarter. The latest performance is excellent given the decline of 0.8% in agriculture: industry and services are doing well. The index of industrial production estimates manufacturing growth at a dizzy 11.3% in October. Exports have shot up 24% in the first eight months of the financial year. Portfolio investment by FIIs hit a record $ 8.4 billion in 2004 despite a panic outflow after the election upset in May. Textiles, India\’s biggest industry, will get a boost from the abolition of import quotas under WTO rules.

Few years have begun on a better note. But I see many dark clouds on the horizon. We live in a globalised world, and our ups and downs can be traced more to global developments than domestic ones. India did well in 2004 mainly because the whole world did well. Global GDP rose by 5.3%, one of the highest rates ever. Even Africa and Latin America boomed, aided by high commodity demand mainly from China. Capital flows to all emerging markets shot up as the dollar weakened. The MSCI index for emerging markets rose almost 22% in 2004. Stockmarkets shot up by 44.6% in Mexico, 44.6% in Indonesia, 39.1% in Pakistan, 34.9% in Venezuela, 26.4% in the Philippines, 21.9% in South Africa.

India\’s 13% Sensex rise was well below the emerging market average. And without FII inflows, the Sensex would have crashed: domestic funds were net sellers most of the year.This underlines our dependence on foreign investors, who can be highly volatile.

If the world economy turns sour in 2005–and there are several reasons why it could–then the global tide that currently lifts all boats will cease to ensure Indian buoyancy. India has a resilient economy, and withstood the Asian financial crisis of 1997-99 far better than its neighbours. However, India\’s booming merchandise and service exports means that the country is steadily becoming more dependent on global markets. So, whether India booms or fades in 2005 will have little to do with Manmohan Singh and a lot to do with global trends.

Most global markets are booming, a sign of confidence. To the surprise of many (including me), high oil prices have not spooked economies. Fears of terrorist attacks have receded. Alan Greenspan, head of the Federal Reserve Board in the USA, thinks the US economy is in good shape. A recent poll of US economists gives a mean prediction of 3.8% GDP growth in 2005, which would be a strong performance for the fourth year of recovery from a downturn.

Yet there are many sobering signs too. GDP growth has slowed to almost zero in Japan, and to barely 1% in the Euro zone. Commodity prices have started falling after peaking in autumn, and this could be an early warning of a recession. In 2004, commodity prices rose 1.8% in dollar terms, but fell 6.4% in euros and 1.8% in yen. Metals did well, but agricultural items slumped in price, especially cotton and cocoa.

A last-minute surge in December carried the Dow Jones index into positive territory in 2004, but it was a shaky improvement. A Merril Lynch report says that the ratio of US company directors selling stock to buying stock in their own companies was 6:1, a ratio exceeded only once in then last 30 years. So, insiders lack confidece.

The dollar has fallen and continues to fall. Given that the US is runnig record trade and fiscal deficits, the wonder is that the dollar is not weaker. It has fallen a lot from its peak when the euro was worth $ 0.80, but less so from the $ 1.17 when the euro was launched in 1999. Indeed, taking the euro basket back to earlier years, we find that it was strongest in 1992 at $ 1.42. Optimists will say this shows that the dollar has not fallen that much. Pessimists will say it proves that the dollar has a long way to fall yet.

Asian countries (including India) have bid up the dollar by parking much of their foreign exchange reserves in US securities. But they are now diversifying into other currencies. So, while a gradual slide of the dollar is more likely than a sudden collapse, the latter remains on the cards. A dollar collapse will mean unbearable currency appreciation for Europe and Japan, pushing them into recession.

It would be rash to be an outright optimist or pessimist. I see a 50% chance of a global boom and 50% of a recession. Critics will say I am dodging an outright prediction either way. In defence, I will say I am taking a strong position by giving a recession as much as a fifty-fifty chance.

Optimists still swear by the Goldilocks theory, that the US economy will be neither too hot nor too cold, and coast along at 4% because of high deficits financed at low cost by Asian countries. Maybe so. Yet if the US economy remains buoyant (and by implication Asian economies do too), the consequent demand for oil could push prices through the roof, to maybe $ 70. That could be a party-pooper.

In other words, there is something to be said for a reverse Goldilocks theory, with the world economy being either too hot or too cold. Remember too that the story ends unhappily with Goldlocks fleeing. In market parlance, you could call it a victory for the bears. 

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