This week we had the IMF economics department arrange a presentation by Raghuram Rajan in Singapore on their ?Global economic and Asian economic outlook? for 2006. Their central view is that global GDP growth in 2006 would be as high as in 2005, at 4.3%. At the same time, the Fund is concerned at the major risks to this forecast: the price of crude oil, the US housing market and global current account imbalances, captured by the polar extremes, of the US with its near 7% deficit/GDP ratio and China with its 7% surplus/GDP ratio.
Nonetheless, by making a global GDP growth forecast of 4.3%, which is a rather high number, the Fund is stating none of these risks would become big enough to endanger the outcome they project. That is plausible for at least two of the risks they cited. The oil price could come down. It had begun to happen; more is needed. Crude oil priced at above $60 a barrel is injurious to a 4.3% growth forecast. It is not clear if the IMF had forecast the price to decline to $40-50 a barrel in the course of next year. If it had not, then there is a tension between the growth forecast and the one for the price of oil. I am comfortable predicting it for them.
The second risk is the US housing market. Research by the Fund in the past has pointed out that the US housing market is less egregiously valued than that of the UK, Australia, Spain, France, Ireland and Greece. Still, even if the housing market corrects, it need not necessarily result in steep price declines. Home investors, in contrast to home owners, would be hurt. Luckily, the proportion of home investors has been relatively smaller than in, for example, Australia. The proportion of home borrowers with adjustable rate mortgages, though higher than in the past, is still a minority. Even in nominal terms, 30-year fixed mortgage rates are below the level when the Federal Reserve started tightening monetary policy in June 2004. Further, the job market has been improving, with falling jobless rates and steady employment gains.
Therefore, both the housing market and the oil price scenarios need not be disruptive of the Fund?s growth forecast.
The current account imbalances are trickier. If the IMF growth forecast is realised, these imbalances in the world will worsen, not improve. The US and China are the two growth engines. Well, make that one. The global growth engine is the US and China?s growth is sustained by exporting to the US. That is why a large growing economy is running an unusually large current account surplus. In other words, for the IMF forecast to be met, growth in the Eurozone and in Japan should be dramatically higher. The Fund concedes this is unlikely to happen next year.
The rest of Asia (ex-China and ex-Japan) should also improve its domestic investment spending. Again, a multi-year task. Hence, meeting the Fund?s official growth forecast would mean the US consumes and China exports. China, in turn, funds the US consumer by buying US Treasuries, mortgage securities, etc. In other words, more of the same in 2006. By year-end, the global current account imbalances would be even larger. This is the Fund?s implied forecast.
Medium-term answer: there is a way out, but that would not solve the problem in 2006. The rest of Asia should strive for more balanced growth. Cultural emphasis on real estate acquisition, in the absence of social safety nets and well developed mortgage markets, makes households save more. If the real estate market is allowed to function without governments manipulating these, they would become more easily affordable. But, there is a catch. In the short term, it would cause pain. Governments should step in and raise fiscal spending to ameliorate this with direct fiscal intervention and higher infrastructure spending. Some governments were about to do this?Indonesia and Thailand?but the energy crisis intervened. Hence, continued focus on energy conservation and consumption is required. In short, the key is to make homes more affordable and cars less so, supplemented with fiscal deficits.
Short-term solution: one more reason for Asian governments to embark on all this soon. Their export-led growth model is well past its ?sell by? date. Asian governments would be fighting a losing battle with China for export share. South Korea saw its exports to China rise as the latter was growing. Now, China is displacing the former in world markets (e.g. steel). China?s growth from here on would not benefit but hurt Asia. Unfortunately, it does not get better if China?s growth falters. If China slows due to domestic credit contraction, profit squeeze and property bust, its presence, in world markets with prices marked down, would be felt even more. That would be worse for Asia. Strange as it may sound, East Asians use to worshipping and fearing China alternately should now pray for the Japanese growth story to develop fully.
And for American consumers to keep flipping homes. To reiterate, this is not a story for 2006. If growth in the US is about Americans selling homes to one another, financed by the Chinese (courtesy Paul Krugman) and if the rest of the world is dependent on this activity for their own growth, this says more about policy paralysis or incompetence in the rest of the world than in the US. The Federal Reserve appears keen to stop the show. If they succeed more than they want, the Fund and the world can kiss goodbye to 4%-plus growth in 2006. It is both disturbing and comforting that the IMF is simply projecting a continued reliance on this to feed global growth.
The writer is the founder-director of Libran Asset Management (Pte) Ltd in Singapore. These are his personal views
