Goldilocks goes global

Table: Global growth rates, % per year

Note: the IMF projections understate India’s actual performance

Source: World Economic Outlook, IMF 2005

Foreigners keep asking me why India’s economy  is doing so well, with GDP growth exceeding 7% per year.  I reply that India is doing well for reasons beyond its control.

Look at it this way. Sub-Saharan Africa, whose GDP grew at less than 3% a year through the entire 1990s, grew at 5.1 in 2004, 5.2% in 2005 and is projected to grow by 5.6% in the fiscal year ending 2006. In other words, India is growing about 1.5% a year faster than sub-Saharan Africa. If India is merely doing somewhat better than the worst-performing region in the world, why get euphoric?

The fragments of the former Soviet Union that splintered in 1990 often fared worse than even Africa. Yet the IMF’s World Economic Outlook (2005) shows that the former Soviet fragments grew by no less than 8.2% in 2004 and 6.5% in 2005. To put things in perspective, India is doing about as well as Kyrgyzstan, Mozambique, Tajikistan and Uganda.

Why is the world economy faring so well that the worst historical performers are suddenly looking good? Africans and the fragments of the former Soviet Union are patting themselves on the back for reforming and becoming so efficient. But this is an illusion. The world economy has hit a golden patch, and a rising global tide has lifted all boats, even the most pitiful ones.  India has benefited from this rising tide, like others. But it is illusory to think that our policies and projects have suddenly improved dramatically and solved our growth problems. When the global tide falls, so will our growth.

Remember the Goldilocks analogy used by US stock market analysts in the late 1990s. The fairy tale of Goldilocks says that the young girl wandered into the house of the three bears and sat down to taste the porridge in the three bowls of the three bears. The first bowl was too hot. The second was too cold. The third was just right, and Goldilocks finished it off in a jiffy.

The US economy in the late 1990s was described as a Goldilocks economy, neither too hot nor too cold, just right. This propelled GDP growth into the longest peacetime boom in the US,  with the Dow and Nasdaq leaping to record heights.

 Alas, the markets had forgotten that the Goldilocks story had an unhappy ending, with the girl fleeing.  Indeed, to use market jargon, you could say the story ended in a victory for the bears.

The technology bust and global recession of 2001 ended the Goldilocks refrain in the US. Yet I would venture to say that the girl has re-emerged in global form. The entire world economy is enjoying a golden period, neither too hot nor too cold, just right.  Goldilocks has gone global.

Consider the extraordinarily favourable combination of circumstances in the last few years. World  liquidity is massive, thanks mainly to very low (and negative) real interest rats in the USA. The fiscal deficit is also at record levels, injecting billions of dollars and driving demand in not just the American but global markets.

So we have a huge surge of global demand accompanied by a surge of world liquidity. High liquidity has not only kept real interest rates low, but dramatically reduced the spreads between rich and emerging markets. One consequence is that Reliance can now borrow more cheaply than General Motors or Ford !

Remarkably, surging demand and low interest rates have not led to runaway inflation as in past booms. Despite record oil prices and booming  commodity prices in general, core inflation (excluding food and fuel prices) is just 2% in the US and Europe. Why? Because global manufacturing has shifted in a big way to China and global services to India, and these low-cost centres have put a lid on global prices.

Despite record oil prices, no developing country has gone bust and run to the IMF, not even the usual sluggards of Africa. Why? Because the overall commodity boom has lifted all African economies, even those that import oil, and low manufactured prices mean that the terms of trade of African countries have improved greatly.

Despite huge global imbalances, the IMF finds it has nobody to lend to. Why? Because  the only country with a huge balance of payments problem is the USA.  It has a very large trade gap of $ 700 billion a year. But the US can simply print domestic currency—dollars– to finance its deficit. So, the IMF remains severely underemployed despite what looks at first sight like a colossal  international trade imbalance.

Demand is buoyant for every sort of commodity, manufacture and service. The main reason is US demand. The household savings rate in the USA has dropped from 2 % to minus 1.8% or so. Americans are spending like mad because of a huge wealth effect arising from booming home prices. Mortgage companies are giving massive home equity loans to home-owners against the rise in their house price, and this enables them to spend much more than they earn (hence the negative household savings rate).

This happy combination of events has created an unprecedented global Goldilocks era, where things are just right. To me, it looks too good to last. Goldilocks may be feeling very happy right now, but the bears will soon come home and give her a rude awakening.

Some of today’s favourable circumstances will surely turn downward, causing a recession, currency crises and much else. I do not when the problem will strike. It may be tomorrow, or may be several years hence.  But when the downturn comes, India will be hit much harder than in past global recessions. India is now more globalised than before, with exports and imports of goods and services approaching half of GDP.

So, do not assume that India’s economic growth is on autopilot, and  will effortlessly leap upwards to 8%.  On the contrary, if the global economy turns sour, I would expect a  return— hopefully only temporarily– to 5-6% growth. India’s long-term story is a good one, but has been inflated in the telling by Miss Global Goldilocks.