The news on Thursday last week of a surprisingly strong April-June quarter growth in Germany and France is only the latest in a series of news releases indicating that the global economy is on the verge of, or even into, a recovery. Economic data from the US, the UK, some Asian countries and, of course, China have increasingly indicated that, born of the multiple stimulus measures, consumption has started to increase. The Federal Reserve states that ?economic activity (in the US) is levelling out?. Is it time, then, to heave a sigh of relief? Or is there a chance of a double dip?
To the limited extent that signs of global recovery indicate that the potential of a fresh crisis has diminished, we are probably still some way off from a strong recovery. Consider the factors that have been widely acknowledged to be the most potent drags on a quick and sustained recovery: high and increasing unemployment, weak housing markets, high household debt, largely frozen bank credit and weak global trade. It is now generally accepted that whatever recovery happens will be a relatively jobless one for the next couple of years at least. The other indicators are likely to determine the pace of growth, working over different horizons.
Start with housing markets in the US, the genesis of the crisis. While both new and existing home sales, house prices and housing starts and permits have been increasing and home inventories falling, there still remain significant risks of higher delinquencies and foreclosures. Commercial real estate remains a problem, and the exposure of many banks in the US, particularly regional banks, will keep the FDIC and other regulators on their toes.
The second impediment has been a very anaemic recovery of credit flows, particularly export credit. The confederation of British industries? access to finance survey in August found among respondents (although among larger companies) who had sought credit in the second quarter, a net response of 18% stating an improvement, compared to a negative 20% in the May survey. Regular credit flows in the US, contrary to perception, had not contracted significantly and are still increasing incrementally.
However, the pre-crisis credit explosion had largely been through securitised and derivative instruments, and these markets will take some time to start functioning. The hardest hit was the asset backed commercial paper market, and there are signs of recovery here. While global risk aversion levels have come off, measured in different segments through multiple indicators, indicating a willingness to lend, particularly short-term funds.
The overnight index swap (OIS) rate is the cost of swapping the variable Libor into fixed rate funds of a specified maturity, and is a proxy for credit risk. The Libor-OIS spreads for 3 month and 1 year funds indicate that near-term markets have normalised to a large extent, but longer maturity funds still remain relatively expensive.
A collapse of global trade has been the third manifestation in the slowdown, and it is surmised that a significant part of this was due to an evaporation of trade finance. While data on trade finance is difficult to come by, and on trade flows only with a lag, a proxy indicator is the Baltic dry freight index (BDI). The BDI has improved over the past quarter, after a precipitous 90% drop in the index post September 2008.
Where do we go from here? What are the residual risks in the system? One is the chance of asset bubbles building up in the system, particularly in commodity markets. Prices of crude and industrial raw materials increasing too soon will choke off economic recovery. The US CFTC and UK FSA have initiated hearings on the extent of controls that might be needed on commodities markets.
The emerging growth impulses seem to be largely generated by fiscal stimulus programmes. These will necessarily have to be gradually withdrawn over the next year. How are global central banks likely to sequence their exit options? How long will governments continue with stimulus programmes? How is private consumption going to sustain when these support measures are withdrawn? Even as more funds are becoming available, there still does not seem to be adequate demand, given weak consumption, inventory stocks and spare capacities. Household debt in the US, for instance, is still around 130% of disposable income. The financial obligations ratio (which includes mortgage payments, auto leases, and rental payments for tenants), still remains at 18.5%, just slightly down from the 2007 highs and households are saving more. This leaves little room for a sustained increase in debt-financed household consumption, the main driver that has helped recovery in past slowdowns.
The situation now is still too fluid to firm a view of the next six months, but the balance of probability is that recovery will be anaemic over the next twelve months. Watch this space, as they say.
?The author is vice-president, business and economic research, Axis Bank. These are his personal views