WHAT'S NEXT FOR THE INDIAN AND GLOBAL ECONOMY? 

By, Adhvith Dhuddu

The dust seems to have settled from the tremors of the Lehman collapse, and the turbulent Sept-Nov period last year. More economists, businesspersons and governments are coming to terms with the true depth and nature of this economic crisis. Markets are still at relative lows even after a substantial rebound, and GDP and trade estimates are still very conservative; but what’s next for the global economy, and how do we know that we are truly recovering? Both here and in the US, volatility indices for major stock indices have subsided reflecting the departure of fear and anxiety in the markets. But here are some critical leading and lagging indicators that will shine more light on the economic picture going forward.

Velocity of Money: Although rarely discussed in the mainstream media, the velocity of money is vital in abetting recoveries all over the globeWW. The G-20 nations recently committed to pumping in billions throughout the global economy hoping to jump start the revival. This huge government spending spree will be ineffective if the velocity of money does not pick up pace. The velocity of money is basically the average frequency with which money is spent in a specific period of time.

The most recent boom periods during the 1990s in the USA and the last decade in India did not happen because of unprecedented government spending, or huge stimulus packages. During these boom periods, even though the amount of money in the system grew steadily, the velocity of money was extremely high leading to healthy growth rates. This is just another reflection of consumer sentiment; when the mood is sanguine, the consumer tends to spend more and save less (which results in a higher velocity of money) but the reverse is happening now. If the billions being ploughed in don’t initiate a rejuvenated spending cycle or if the velocity of money doesn’t garner momentum, this downturn can last a while.

Another vital component of the velocity of money is the money created in the system through securitization and the shadow banking system. The velocity of money increased gradually over the last decade because it was also aided by financial innovation and securitization. Even though it’s 6-7 months after the crisis the shadow banking system is still in tatters and will take time to recover.

Deflationary threat: Going back to the basics, we learn that inflation is caused when more money is chasing a limited number of goods and services. We saw this unfold in an ugly manner at the height of our recent economic expansion. Now, inflation is at zero levels and many speak of a dangerous deflationary spiral. Although our Planning Commission’s Deputy Chairman, Dr. Ahluwalia has dismissed these fears, they are real and present dangers for a simple reason, now there is less and less money chasing the same number of goods and services.

It’s an oversimplified explanation for a potentially complex problem. But this is true for many reasons; no banks here or anywhere in the world can now borrow with 1:30 leverage. In the pre-crisis days, $10 million could result in $300 million worth of investment/spending spread over the globe, and let’s say 25 percent of that is allocated equally to BRIC countries: India would probably see $18.75 million (Rs. 93.7 crore) worth of investments. But now, if investment banks or any investor can secure 1:10 leverage, the same equation would bring only $6.25 million (Rs. 31.2 crore) to India. This trickles down and when there is less money to trickle down, everyone has less to spend and less to save, which starts suppressing prices. This is already happening here and across the world. Consumers are either spending less or delaying their spending plans leading to lower sales and retailers cutting prices.

Recent data from the RBI and other private banks are only rubbing salt to the wound. Despite proactive measures from the RBI, lending growth in the latest fiscal fell by 5 percentage points from 22.3 percent in 2008 to 17.3 percent in 2009, way off their own target of 24 percent (non-food credit by scheduled commercial banks). This is relevant because credit is a form of money in the system; reinforcing the fact that now there is less money chasing the same goods and services.

Stock market rebound: In efficient markets, stock prices are reflective of the future earnings stream but in the current scenario, one needs to accept the global rebound in indices with a pinch of salt. Technical analysis is a passion of mine, and we learn in the basics of technical analysis that when any chart appears heavily oversold, there is eventually a rebound. So this mini-rally across the globe is primarily due to two reasons: It’s a snap back of the spring to rebound coupled with subtle signs of optimism in a few macro indicators. Helping the rebound along the way is short-covering; but this rally will eventually lose steam and test the recent lows of the Sensex and Nifty.

Success of TARP, TALF and PPIP: If a $13 trillion economy doesn’t get going in a $50 trillion global economy, we might have some serious troubles ahead. Yes, there are possibilities that one of the BRIC countries or emerging markets as a whole could dampen the overall blow and lead the way out of this crisis. One must cautiously accept this because it has never happened before and will be an unprecedented and monumental feat if achieved.

This is why the success of TARP (Troubled Assets Relief Program), TALF (Term Asset-Backed Securities Loan Facility) and PPIP (Public-Private Investment Program) is vital. These flagship programs designed by the US government to pull their economy out of turmoil has so far been progressing according to plan which is why US president Barack Obama recently said he saw, “glimmers of hope,” in the economy. 

These and other pivotal factors like better trade numbers, a flight from safe havens like gold and government bonds and how well the reformed securitization market serves the recovery will be keys to the recovery. But one thing is certain; the capitalist system that emerges out of this financial crisis will be regulated more closely, monitored more vigilantly and animal spirits will now have shackles to break. 

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