Saturday, Dec 27, 2014

Dubai: The US economy is accelerating and is expected to achieve GDP [gross domestic product] growth of 3 per cent next year, but economists say that is not enough to combat the global aggregate demand slow down resulting from contraction in China, Japan, Europe and emerging markets put together.

The biggest slowdown in demand is coming from Chinas housing market. The sector, which has been the main locomotive of growth for the past decade is faltering and so is business investment and factory output.

China is currently navigating the slowest GDP growth for a quarter century. The government is trying to speed up restructuring of its economy in order to spur private investment and domestic consumption. This is part of its strategy to wean the economy off its addiction to debt, now running at over 250 per cent of GDP.

The simultaneous slowdown of China and surge of US GDP are resulting in a massive commodity price slump, especially a steep fall in oil prices as US supply is on the rise and Chinese demand is waning. The upswing in the US growth and decline in oil prices have seen the flight of global investors from oil and emerging market asset classes to dollar and US treasuries resulting in the rise of the dollar. The surge of the dollar in turn is contributing to a further safe haven rush into dollar denominated asset classes.

Although the US economy is seen reversing its fortunes in terms of GDP growth, leading economists say the world faces the threat of another recession leading to asset price deflation and commodity slump resulting largely from collective deleveraging and demand contraction.

Experience across the world following the global financial crisis shows that fighting deleveraging has proven difficult. While leveraging up [spending through borrowing] can be checked with higher interest rates, deleveraging cant be offset equally through rate cuts, said Paul Krugman, Professor of Economics at Princeton University and winner of the Nobel Prize in Economics in 2008, at a recent conference in Dubai.

Krugman attributes the current role reversal of the US versus China and other leading emerging markets are largely linked to lack of spending. The boom in emerging markets that followed the financial crisis has been short-lived. Many are slowing due to varying reasons but on a common theme of lower spending. Thus we have a world economy once again caught up in deleveraging, said Krugman.

Many commentators now expect Chinas GDP for this year to fall short of the governments 7.5 per cent target. Even the target figure represents Chinas slowest annual growth since 1990.

High short-term costs

Chinese policymakers appear to be focused on the quality of structural reforms rather than GDP growth. Ideally, this will improve a long-run growth sustainability by optimising resource allocation. However, the short-term costs are high, especially for an economy that has shown increasing signs of vulnerability since 2008.

We expect GDP growth to moderate further, to 6.8 per cent in 2015 from 7.4 per cent in 2014, an already-low number by recent Chinese standards, said Neville Hill, an analyst with Credit Suisse.

Oil tail spin

The current turmoil in global commodity markets, mainly the sharp decline in oil prices has been driven partly by supply surge in the US from shale output but largely from slowdown in Chinese demand

China is suffering historically unprecedented levels of overcapacity for everything from steel to solar panels and housing market. House sales nationally fell by 10 per cent in 2014 and the country now has around seven years worth of unsold housing inventory. China Investment Network, a business newspaper in Beijing recently published a ghost town index stating there are at least 50 cities in which half or more of the housing is unoccupied.

Chinas construction sector consumes around half the worlds steel and cement and employs 37 million people. The past decades building boom has therefore also been a huge driver of global energy prices, with China accounting for more than half the worlds construction activity. With the housing slump energy demand in China has taken a beating with medium term implications for oil prices.

Overall consumption

The slump in commodity markets has led many economic commentators to again question Chinas official GDP figures. Reform-induced political and economic uncertainties have also overshadowed household income and wealth growth. We expect overall consumption to be relatively resilient next year, if property prices stabilise at low levels, service-sector income growth should improve and saving rates should decline. These assumptions partly rely on policy success in rebalancing the economy toward consumption and away from investment. Housing policies have significantly eased, particularly for non-speculative buyers, said Credit Suisses Hill.

Despite moderating growth, aggressive counter-cyclical fiscal or credit policy is very unlikely unless systemic distress occurs. Analysts expect monetary policy to accommodate economic transitions and prevent liquidity crises from debt service rollover. Despite this years debt-maturity extension in the local bond market, significant debt rollover is expected in early 2015, a risk possibly magnified by a likely soft patch in growth.

By Babu Das Augustine Banking Editor

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