Saturday, October 17, 2009

End of recession - an update

The Times points to a survey of major developed and emerging economies on manufacturing output, new orders, and unemployment trends, which finds definitive signs that a recovery, albeit with varying pace, is underway. Though output and orders are up, unemployment, being a lagging indicator, is still on the rise.

It is clear that much of Europe continues to remain subdued and the best that can be said being that it is "getting worse slower than before"! In fact, with even the US slowly pulling out of the recession, there is a real danger of Europe being left behind with the possibility of another decade of "Eurosclerosis" as in the nineties. Unlike the US, many European economies are deeply dependent on exports to drive economic growth and the recession has taken a toll on global trade, and there is a possibility that trade will remain anemic for the foreseeable future.

Further, unlike the US and other major economies, the Europeans have extensive social safety nets, which while cushioned its citizens from much of the adverse consequences of a recession, has also put massive burdens on the governments. If the economic prospects do not improve soon, governments will come under intense pressure with deficits and the EU Stability Pact conditions to sustain the elaborate social safety stabilizers.

The recession has also put back efforts at addressing important long term concerns arising from an aging population, stagnant population growth, inflexible labor markets, and generous social safety nets that affects business competitiveness. It is increasingly becoming apparent that as Simon Johnson writes, "The Europeans are the biggest losers of the economic crisis, even though the home of subprime madness was the US". Interestingly, the net job creation remains stagnant in India.

Even as the trends with Main Street appear mixed, the financial markets in both developed and emerging economies have been galloping along, and recovering the lost ground. In an indication of return to old times, many of the Wall Street majors have posted record profits and announced the same massive bonuses. The financial markets in emerging economies have jumped by more than 50% since March this year, on the face of massive inflows of capital from US and other developed economies.

The low interest rates across the world, and especially in the US and Europe, has been a major contributing factor in the boom in equity markets. The resultant mis-allocation of resources to the equity markets may cause an asset bubble to get blown up. The graphic below indicates the steep rise in foreign capital inflows into India, even as the equity markets have almost doubled.

It also appears that the severity of the current recession may not have done enough to prevent the build up of more macroeconomic imbalances. The Chinese insistence to peg the renminbi to dollar and the recent depreciation of dollar against all the major currencies, has meant that the Chinese Central Banks has been buying up dollars to keep the renminbi falling along with the dollar. The result is a further build-up of surplus reserves and prevention of any substantial change in the direction of trade account with the US.

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