Avoiding the great depression

Jayshree Sengupta

IF you went on a holiday to Europe, the US or even in India this summer, and wanted to buy a souvenir or something that you fancied, chances are that it was ‘Made in China’. Yes, everything seems to be made in China, from shoes to expensive handbags, cosmetics, trinkets and phones. Yet China is supposed to be slowing down and growing at 7 per cent, the lowest growth rate since 2009. 

China’s slowdown is also ominous to those countries, including India, which have been selling quantities of raw materials to China. It seems that China has a huge stockpile of steel and other raw materials in its backyard.

India has been facing export slowdown in recent months. Exports fell by 20 per cent in May 2015. Other emerging market countries in Asia are also facing similar export slowdown, partly because of China’s slow growth. In the case of India, the fall in petroleum price also led to lower dollar export earnings of refined petroleum products that India specialises in.

Europe, which has been a big trade partner of India, has been experiencing sluggish GDP growth in the last few years, and the fact that EU has been grappling with Greece crisis for a year, has taken a toll on its exports and imports. Except for Germany, other EU members have been facing slow growth in trade. Severe austerity measures were applied to Greece and others like Portugal and Spain, which slowed down people’s demand for goods in these countries from emerging market countries. 

There has also been a rise in youth unemployment and various other budgetary cuts have led to reduced disposable incomes in the Eurozone area. The other reason for the slowdown in emerging market economies is the slackening growth of US demand.

The US is just coming out of recession and has been following quantitative easing and near-zero rate of interest in order to revive demand and investment and kick start its economy. But the quantitative easing (with the Federal Reserve buying US Treasury Bonds) that has increased liquidity in the world financial system by releasing around $4 trillion has led to FIIs flooding the emerging markets, playing havoc with their exchange rates. In India, the FII inflows at the beginning of 2015 led to the hardening of the rupee, which further contributed to the export slowdown. 

The European Union has also resorted to quantitative easing in the face of the Greece crisis and Japan has been undertaking monetary expansionist policy for quite some time to revive growth. All this has released a lot of money in the international financial system which has disturbed currency rates in emerging markets vis-à-vis the dollar. It has led to intense competition for increasing export growth and resorting to competitive devaluation.

This trend has been seen before and was referred to by Reserve Bank Governor Raghuram Rajan when he talked about the world facing 1930s type of Depression. He has called out to Central Banks to review the rules of the game of monetary easing, which has led to FIIs seeking best returns in the emerging markets moving funds from one country to another.

A new phenomenon has been that China's stock markets have gained enormously due to FIIs swarming towards the Chinese market and leaving other countries, including India, abruptly. As a global giant, China's stock markets went up by 125 per cent in the last one year, despite the fact that China’s growth was slowing down. Chinese companies apparently made a lot of money just playing on the stock markets and did not have to produce anything! China’s stock market has been full of small investors and 8 million new trading accounts were opened in the first quarter of 2015.

The Chinese government has promoted the growth of the stock market as a tool for financial reform, like reducing the economy’s dependence on bank lending. But the government has been concerned about ‘margin’ lending when the investor started borrowing from brokers. Also, as a result of the stock market boom, a stream of new companies started listing their shares on the market. Rumour about new IPOs in China led to FIIs flocking to China and leaving the Indian market leading to a stock market crash. 

However, on June 29, there has been a correction and the Shanghai Composite fell by 20 per cent and Shenzen composite by 6 per cent. The central bank of China has cut one year lending and deposit rates by 0.25 per cent. The correction was because the stock market rise was not backed up by economic fundamentals.

If there is a stock market crash in China, there will be further cause for worry because the repercussions will be reflected in other stock markets, like in India. The FIIs may return to India causing problems in the exchange rate of the rupee. The RBI Governor may also reduce the interest rate further to revive the slackening economy by incentivising investment. But there is little doubt that the world economy and trade are slowing down, and all because of the cooling off of the Chinese economy and the revival tactics of the central banks in the developed economies. Low interest rates and quantitative easing is only increasing the risk of Great Depression from becoming a reality. 

The IMF has contested the scenario of another Great Depression and has come out with a paper pointing out positive trends in the world economy. India will have to do more to speed up its own financial sector reforms and make it stronger because the percentage of NPAs has reached a dangerous level of 4.45 per cent and could reach 6 per cent soon. Unless the banking system is strong, India cannot be on a higher trajectory of growth. According to the RBI, the banking system needs recapitalisation of more than the budgeted amount of $1.3 billion. India can then depend on its own money to finance its manufacturing sector and ‘Make in India’ dream. Depending on hot money in an era of financial easing of developed countries will make India’s growth vulnerable to shocks.