The Hindu Business Line : Global economy direly needs antidote

A new study estimates credit will contract $2 trillion as financial institutions repair balance sheets. That puts a lot of new lending on hold, which means less spending (the American economy is credit-driven, if not anything else) and considerably increases the odds of a recession.

Last week’s data did little to dispel the notion of the US economy slipping into reverse gear. Retail sales were anaemic and industrial production was the lowest in six months, falling 0.5 per cent.

Worrying factor

Another big worry is the sharply diminishing appetite of foreigners for dollar assets. They actually net sold US securities for the second month in succession, confirming the reserves shift away from the greenback into other currencies, mainly the euro. The risk is that this trend could counteract the Fed cutting rates, keeping bond yields much higher than short rates and neutralising a soft monetary policy.

The need is, therefore, for a strong dollar, as the US Treasury Secretary, Mr Henry Paulson, keeps saying over and over again. For, more than anything, it is the dollar’s vulnerability which, in recent times, has prompted currency diversification of reserves.

Herein lies the dilemma. The state of the US economy requires low interest rates and more consumer and business spending. The latter means a large trade deficit – precisely the factor weakening the dollar.

America must export more. Equally, emerging economies must consume more (although if it will specifically help US exports more than others — forget the global environmental implications — is a question mark). Talk of squaring a circle!

Domestic inflation edged up to a little over 3 per cent. Growth concerns resurfaced with industrial production dipping sharply in September. As the RBI hit the market with the latest CRR hike and bond issues, liquidity has contracted to the point where banks have turned borrowers from the RBI. Money rates are now above the central bank’s repo rate.

Government is starting to axe spending. Hence, the near-term outlook for liquidity is entirely a function of how much the RBI will (need to) intervene in the forex market. And that, in turn, is a function of the stock market’s direction, which, again, depends on global cues.

If anything can be said with certainty, it is that a convincing and significant fall in the price of oil is a prerequisite for sustained market confidence and global growth. A powerful antidote to the anxiety now enveloping governments, central banks, consumers and businesses is a necessity.

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