The world economy has definitely seen better times. The World Bank?s recently released report, Global Development Finance 2008, outlines the extent of the malaise and attempts to guess the after-storm reality. It is certainly not a pretty picture. Growth has slowed worldwide since 2007. The US growth rate is expected to roughly halve to about 1.1%, while those in Japan and the Euro area have been revised downward to 1.4% and 1.7% respectively. At the same time, inflation has soared almost everywhere.
Few doubt that rising global prices of oil and commodities lay at the heart of both. Since 2005, prices of food staples have more than doubled in nominal terms. The real price of rice hit a 19-year high in March. Almost at the same time, wheat reached its 28-year record at a price that is almost double the average price over the last 25 years. Oil prices, of course, have more than doubled in a year?s time. With growth in demand for oil slowing from 3.6% in 2004 to a crawl of 1% in 2006 and 2007, slow output growth?Opec constraints and sluggish growth in non-Opec output?largely accounts for this. To add to the woes, the financial crisis in developed countries has stopped the record private capital flows to developing countries, making liquidity hard to come by.
How are the emerging market economies reacting to this slowdown-inflation-credit squeeze combine? Using data till mid-May, the expected drop in growth in all emerging markets together is a hefty one-sixth?from 7.8% in 2007 to 6.5% in 2008. Among regions, the drop is expected to be most severe in East Asia and the Pacific at 1.9%, with China, with an expected drop of 2.5% leading the pack. India?s expected drop in growth is 1.7%, only behind China and Argentina. That said, with a projected growth rate of 7% in 2008, India would have the fourth highest growth rate among emerging markets behind China and oil-exporting Nigeria and snapping at the heels of Russia. Nigeria?s oil bonanza, incidentally, is expected to raise its growth rate from 6.1% to 7.9%, boosting the rate for the entire Sub-Saharan Africa by about 20 basis points.
Rising oil and food prices have translated into higher inflation across the board in the developing world. ADB is considering revising upward its projection of 7.6% inflation rate for Asia outside Japan. Vietnam is reeling under an inflation rate exceeding 25%. China, Singapore, Thailand, Philippines and Indonesia are all experiencing inflation exceeding 7.5%. Food prices have gone up in every country though by considerably less than the rise in the international grain market.
What to expect in the medium-run? World Bank?s projections view the current situation as transient with growth rates in developing countries expected to remain at around 6.4% over 2009 and 2010. For India, the figures are 7.5% and 8% respectively and China is expected to grow at rates exceeding 9%. Things could certainly be better but for most, not worth losing sleep over.
Before we take too much comfort from these projections, however, it makes sense to check their track record. The current projected 2008 growth rate for developing countries, 6.5%, is a far cry from the 7.1% estimated just six months earlier, so newer data has brought bad surprises. By its own admission, the crystal ball is too murky to use for bets. Uncertainty about US growth projections has roughly doubled from 2007 and the possibility of a severe recession cannot be ruled out.
If the US does witness a significant slowdown, the Fed, already averse to tightening, may go for further easing of monetary policy. This would lead to a decline in the value of the dollar, possibly spurring an inflationary expectation spiral at a global scale, setting oil and commodity prices for another round of increase. If that happens, the effects would be far more disastrous than in the recent past. Currently at record levels exceeding $143 per barrel of crude, oil prices remain as unpredictable as ever. And we certainly do not like to hear about the effects of a possible armed conflict involving Iran. Finally, the extent to which the economic slowdown would exacerbate the financial crisis is not clear either, which can have its own effects on international funds flows.
Given all this, the projections in the World Bank report are valid only till the next revision. Both at home and abroad, we are told that the inflationary spike is temporary and things will get better by the end of the third quarter. Let us hope that would not be too late to keep the price expectations from spiraling out of control. Much of that expectation management lies in the hands of monetary authorities around the world. Borrowing a page or two from Paul Volcker?s notes on combating stagflation over a quarter century ago may not hurt them?or us.
Rajesh Chakrabarti teaches finance at the Indian School of Business, Hyderabad