A global slowdown might be inevitable

The year began with great optimism about economic growth. The previous year i.e. 2017 had concluded with actual growth beating earlier estimates of the International Monetary Fund. In the previous six years, the IMF’s usual optimistic forecasts given out at the beginning of the year had to be steadily downgraded as actual growth belied the forecasts. Not 2017, which was surprisingly strong.

But 2018 began with President Trump’s trade sanctions. Trade war talk started escalating, which made stock markets nervous. In February, there was a huge selloff and sharply increased volatility. The Morgan Stanley Capital Index for all world stock markets, dropped by 3 trillion dollars in value. This had a big impact on emerging market economies. Since capital was leaving their markets, the currencies took a big hit. Argentina, Turkey, Indonesia and South Africa currencies were badly affected. In fact, Argentina had to be bailed out by an unprecedented loan from the IMF. Turkey’s President made speeches to investors assuring them of macro stability but to no avail. The currency fell sharply since Turkey’s outstanding debt was three times more than its foreign exchange reserves.

India’s rupee too tumbled, although initially the stock market held up, due to domestic investor support. The monthly inflow of domestic investors into the stock market, thanks to schemes like monthly Systematic Investment Plans (SIPs) are now close to a healthy Rs.10,000 crore, and hence can offset the sudden exit of foreign money. This sudden fall of emerging market currencies brought back memories of 2013, the so called “taper tantrum” caused by remarks of the then Chairman of the Federal Reserve Bank,  Ben Bernanke, in May 2013. But thankfully India was relatively immune until August from the contagion effect of the February stock market crash in the developed economies.

As if the escalating trade war between U.S.A. and China was not enough, President Trump threw in another googly, by announcing that his country would pull out of the nuclear treaty with Iran. This was against the wishes of European allies, yet backed by the President’s conviction that Iran was not complying. He threatened that any third country, like India, China and others, who would continue to import oil from Iran, would face stiff sanctions from the U.S. The deadline given to bring oil imports down to zero was November. This spooked the oil markets.

For instance, India imports 12 per cent of its crude from Iran, and suddenly switching to a new supplier is not easy. The markets braced themselves for a sudden drop in oil supply as Iran’s crude would be shut out, causing oil prices to shoot up. By September, when oil had already climbed to 85 dollars per barrel, there was talk of 100 dollars by December or January, being the peak winter demand for home heating. In India, the exchange rate slid to 75, and many analysts warned that 80 was in sight. This was a double whammy, since oil was shooting up and exchange rate was sliding. 

And yet come November, the U.S. announced relief for eight major importers of Iran’s crude. They were given a six-month extension. In the meantime, President Trump publicly asked, through his tweets and otherwise, the Saudis to pitch in with extra oil, and ensure that oil prices stabilised. The OPEC cartel of oil producers, along with Russia were asked to not resort to any production cuts, to help keep prices low.  In early October, Jamal Ahmad Khashoggi, a Saudi dissident and columnist for the Washington Post, was murdered in Turkey, allegedly by agents of the Saudi government. This was tragic, but also a significant event in global oil and geo-economic diplomacy. Did the murder have an impact on relative bargaining strengths of oil producers and consumers? Did it provide extra leverage for President Trump over Saudi action on oil prices? These are matters for speculation. But inexplicably, oil prices dropped sharply in November and continue to do so this month. From a peak of 85 just three months ago, Brent crude is at 55 and may fall further. This volatility is unheard of, and also inexplicable.

Are oil prices falling because of behind the scenes diplomatic pressure, or because of a slowdown in economic growth, and hence demand? Another evidence comes from interest rates. The yield curve is flattening, and long-term interest rates in the U.S. (the yield on a 10-year bond) has fallen below 3 percent. A higher yield indicates higher growth, and lower yield is a harbinger of recession. That the yield is falling despite record deficits reinforces the view that the U.S. economy is headed for a slowdown. To top it all, the stock market in the U.S. has fallen by ten per cent in December alone. For the calendar year of 2018, the stock market would have fallen cumulatively by about 8 percent (since it did rise till February, and again during the summer months).

The fact that stock market has fallen, despite record corporate profits, means it is indicating a big slowdown, if not a recession in the years to come. 2019 might very well be a year of tepid growth, even as it would be the 11th year of continuous expansion of the U.S. economy. This would be the longest expansion of economy and jobs in post-war America. So statistics have to catch up, aided by rising deficits, and still stagnant corporate investments. Much of corporate profits have gone toward share buyback and paying dividends to shareholders, not in new greenfield mega investments. President Trump has also lost control of the lower house (the Congress) making it more difficult to pass his pro-growth tax cuts for the middle class. The first set of tax cuts helped mostly corporations, not middle class families.

Hence as one reads the various (American) tea leaves, it looks like 2019 will be a year of slowing growth for the world’s largest economy.

(The writer is an economist and Senior Fellow, Takshashila Institution)