As world markets wait nervously for the release of one set of economic data after another from the US, it is becoming clear that we are still in the early stages of an economic reaction to the easy credit conditions that have led to market nervousness and global central bank intervention.
A bumpy road lies ahead, a lowering of interest rates by the Federal Reserve to ease on the credit crunch. Even the UK High Street, which seemed sheltered from the fallout on the US subprime market, has been shocked by the news that Northern Rock, one of Britain’s largest mortgage lenders, had to ask the Bank of England for emergency lending. Northern Rock has assets of around $226 billion in loans and assets, and has been exposed more than its rivals because it is overwhelmingly focused on providing mortgages rather than in a broad range of banking business. The sight of controlled panic, as depositors queued to withdraw their deposits from Northern Rock, sent collective shivers in the UK financial community, and was only partly allayed after the Bank of England made an unprecedented commitment to guarantee all depositors funds.
If such well-established financial institutions are feeling the credit squeeze crunch, then what is the outcome for the market most affected by subprime defaults — the US? Of more importance — will the US go into a recession? Some are predicting “by how much” will the recession bite, and not of “when”. All recent economic data seems to point to a slowdown, and in the best-case scenario, one is looking at two to three years of slow economic growth, rather than downright recession, as the US economy is till reasonably strong.
The difference now on the global economy is that the world is less dependent on demand from the US consumer to drive the engine of growth, than in previous business cycles. The power of incremental consumer demand from China, India and other “new” rising economies such as Russia and Brazil was, during 2007, and for the first time, greater than from the US. How these new rising economies continue to perform, independent of what happens in the US, is of paramount importance for the future and for the Gulf economies in particular. The world could keep growing and trade even if the US goes into a deeper recession.
China, once again, seems to be shouldering this incremental growth, and the World Bank has raised its forecast for China’s economic growth this year by almost 1 percent. This means that China’s economy would expand at an incredible breakneck pace of almost 11.3 percent. This compares with initial predictions of 10.4 percent. What is more interesting is the perceptible change in the internal drivers of the Chinese economy. While strong investments and exports have so far been the main drivers of China’s amazing growth, there is now more confidence that a rise in consumer spending will boost China, even if demand for some of its exports falls. Chinese domestic retail sales have grown by around 17 percent in 2007, up from 16 percent in 2006 spurred on by rising incomes, a larger middle class base and also by a rising inflationary trend. This shift toward a more balanced, domestic consumption base, rather than reliance on exports, is to be welcomed, and analysts predict a continuing consumption trend in China. Just to illustrate the significant amount of domestic liquidity in China, the recent share flotation of the China Construction Bank which hoped to raise around $4 billion, saw a world record staggering amount of $300 billion raised from disappointed local investors. Encouraged by this, another mega float of $10 billion is being planned for China’s biggest coal producer — Shenhua Energy.
The same trends are beginning to appear in the new rising economies such as India, where a rising prosperous middle class and professional class have started to spend more, and save less in traditional manners. One cause of the recent fuss over the rising price of imported Indian basmati rice to Saudi Arabia can be due to the income effect of “new rich” Indians buying more high quality rice for domestic consumption, causing export supply shortfall. We should get used to more of the same in the Gulf for a wider range of consumer goods currently imported from Asia.
The picture is not all rosy though for the new rising economies, and there are some signs of strain in China, especially in inflation that is running at more than 5 percent, with most of the increase coming from food products — not good news for the urban poor of China, many of whom have not yet been touched by the new wealth of the country. While the Chinese are concerned at this rate of inflation, it is not clear how much this reflects a rise in global commodity and energy prices, and how much it is the effect of environmental-related flood problems. Some argue that the rise in global commodity prices have been partially caused by a rise in Chinese commodity demand, but others point to the growth of the domestic stock markets and an increase in money supply as a contributory cause in inflation.
For the time being though, there is much momentum in the new economies that they will be able to see through any downturn in their major overseas markets in reasonable shape, thanks to their newfound domestic growth. For countries in the Gulf that have been establishing strategic economic alliances with these rising new economies, such economic “bets” are now paying off. (Dr. Mohamed Ramady is visiting associate professor, Finance and Economics at King Fahd University of Petroleum and Minerals)