Believers in India Shining will be delighted that GDP grow-th in October-December was 10.4 per cent. Even allowing for the artificial boost given by a good monsoon, India seems to be in the fast lane.
It’s all thanks to Vajpayee, the BJP will tell you. The truth is more complex. Some of the credit goes to a barely recognised phenomenon, the globalisation of pump-priming. US President Bush has been running the biggest fiscal deficit in history, slashing tax rates.
At the same time, the US Federal Reserve has slashed short-term interest rates to barely one per cent, the lowest in recent memory. The combination is a huge economic stimulus — loads of government overspending, backed by dirt-cheap money that encourages a frenzy of borrowing (in order to spend) by households and corporations.
This spending spree aims to boost the US economy, create new jobs rapidly, and hence help re-elect Bush. But things are not working out quite that way. The economy has accelerated, yet is not creating enough jobs to dent unemployment. So the spending spree continues, with Bush hoping things will turn around if only the stimulus is large and long enough.
Why is the biggest pump-priming in history producing such modest results in the US ? One reason is globalisation. Tax cuts are supposed to induce people to buy more goods, reviving domestic production. And cheap money is supposed to stimulate investment in new US factories and offices.
But in a globalised economy, a spending spree by consumers can boost demand for imported rather than domestic goods (this is reflected in the record US trade deficit of $500 billion). Cheap money may indeed induce US corporations to invest, but they may do so in China and India rather than in the US itself.
The situation has been further complicated by the emergence of what Martin Wolf of the Financial Times calls a ‘‘new dollar zone’’, including India and China . The US trade deficit is the largest with Asian countries, and should normally cause Asian currencies to rise sharply against the dollar. But Asian countries resist this. Some, constituting the inner circle of the zone, maintain a fixed exchange rate with the dollar ( China , Hong Kong , Malaysia ).
Several others, constituting the outer circle of the zone, intervene in forex markets to prevent their currencies from appreciating much ( India , Japan , Korea , Taiwan , Russia , Singapore , Thailand ).
What are the implications of this new dollar zone? One is that the stimulus which Bush wants to inject into the US economy leaks heavily into the dollar zone. Overspending should normally cause the US dollar to fall sharply, making imports expensive and inducing more local production. The dollar has indeed fallen sharply against the euro, hitting imports from Europe . But Asian countries have linked themselves wholly or partially to the dollar, thus keeping their exports to the US competitive. By becoming part of the new dollar zone, these countries ensure that their exports benefit from the US spending spree.
They benefit from capital flows too. US capital is flowing massively to all emerging markets, in the form of both direct and portfolio investment. Stock markets have boomed throughout the new dollar zone because money is leaving the low interest rates of the US and flooding into emerging markets. India , in 2003, enjoyed the biggest inflow of portfolio investment in history, and the flow continues this year.
Martin Wolf calculates that the new dollar zone generates 53 per cent of world GDP and contains 52 per cent of world population. Although it is not a formal group, it has major consequences.
One is that the fiscal and monetary stimulus being attempted by the US will not be limited to the US but will spread to the whole dollar zone. Asian countries in the zone refuse to let their currencies depreciate, and take monetary measures to prevent interest rates or inflation from rising locally. They have easy access to US capital and technology, and most have reserves of cheap, under-utilised labour. Some production shifts to countries with cheaper labour, curbing the usual inflationary effects of overspending.
In order to create a US boom, the US authorities find they have to create a stimulus large enough to spark a boom in the entire dollar zone. India is not the only shining economy around, the whole of Asia is shining. Even Japan , after a decade of torpor, enjoyed 6.4 per cent GDP growth in the latest quarter.
The most recent data for industrial growth suggests 23 per cent growth in China , 16.7 per cent in Malaysia , 11.6 per cent in Thailand and 7.5 per cent in Russia , against around 7 per cent in India . All these countries have also enjoyed booming stock markets over the last year.
This is no co-incidence. It is a consequence of the globalisation of the US economic stimulus. Through this, Bush may help re-elect Vajpayee but not himself. How ironic if that happens!