Increase in interest rates in the US will have far more detrimental effects on the rest of the world than any planned reduction of fiscal deficit in the American economy, said Ranjit Teja, deputy director, strategy, policy and review department of the International Monetary Fund (IMF).
In a presentation at Ficci on Tuesday, Teja said fiscal consolidation in the US will reduce demand in the American economy, and thereby in the rest of the world. A reduction in the US deficit would also help in the reducing the interest rates.
But the US fiscal consolidation overall does not have much negative effects on the output levels in the rest of the world. The impact of such a measure is reduce GDP levels in other economies by half a percentage point, he said.
The effects of a crisis in the European coountries would largely come through financial channels, whereas China will be affected mainly through the trade channel.
Teja also highlighted that the deepening of the European banking crisis could trigger “a wave of global credit contraction”.
He added that the first round of quantitative easing (QE) in the US helped in the ameliorating the ?fear and uncertainty? that gripped the world economy in the immediate aftermath of the Lehman crisis in September 2008.
However, the second and third round of QE did not have that much impact on reducing the uncertainty, as gauged from the VIX (or volatility) index. Teja pointed out that QE works best in times of extreme stress.
Speaking about the Chinese economy, Teja said while the low exchange rate has helped China in gaining competitiveness in the global economy; its low cost of capital is another important factor in maintaining the high profitability of its manufacturing sector.
Globally it is observed that real interest rates typically converge closer to the GDP growth rates of economies.
But in the case of China real interest rates have plunged much below GDP growth rate over the years, Teja said. China also provides high subsidies to its manufacturing sector.