Swaminathan S Anklesaria Aiyar , ET Bureau
There is much talk of green shoots heralding the end of the global recession .
Stock markets are shooting up globally.
But the International Monetary Fund (IMF) has just issued its gloomiest
forecast ever. It says world GDP, which has never shrunk since the Great
Depression, will shrink 1.3% in 2009, and then inch up to 1.9% in 2010. Growth
of less than 2% indicates a global recession. So, serious recovery will not
come before 2011.
The government predicts a rapid recovery in the second half of this fiscal
year. The RBI projects 6.5% growth in 2009-10 . But the IMF's projection for
India is just 4.8%. Maybe the IMF will revise its projections upwards . Yet, we
must ask, why is the IMF so downbeat?
Indian economists focus largely on the Indian scene, while the IMF focuses on
the dismal world economy. History shows that recessions accompanied by a
financial crisis are deep and long. India has no financial crisis, and so
Indians are complacent. But the world has a gigantic financial crisis.
The IMF sees world growth being strangled by what it calls negative feedback
loops. The financial crisis first reduces cash flow to producing sectors. This
causes a recession, with producing sectors slashing production and employment.
But the recession then makes the financial crisis worse - more corporations and
individuals default on bank loans. The banks respond by cutting credit further
, and this hits production and employment further. This is the negative
feedback loop.
The IMF now estimates that lending institutions globally may eventually have to
write down a staggering $4 trillion of bad debts, four times India's GDP! The
US is worst off, having to write down $2.7 trillion. But Europe also has to
write down $1.2 trillion, and Japan $149 billion. Faced with this red ink, some
of the biggest global banks are technically bust. They need to raise huge sums
of fresh capital, enough to write off their bad debts and start lending again.
But who will supply so much? Certainly not private investors, who have already
lost a fortune. So governments globally have mounted a massive rescue effort.
In the US, public-private partnerships are also being tried to provide fresh
billions.
Banks have lent too much in relation to their own tangible capital. To move to
the point where their loans come down to 16.5 times their tangible equity - a
conservative target - US banks have to raise an additional $500 billion,
European banks $950 billion, and British banks $250 billion of equity. These
are staggeringly large sums, considering how much rescue money has already been
dished out.
Yet, until the financial sector is made solvent again, it will not restart
lending fast enough to kickstart the world economy. The world needs to go from
negative to positive feedback loops. For that, banks must lend much more to
productive sectors, which will then raise production and employment, which will
then boost bank profits and encourage further lending. That's how the current
vicious cycle can give way to a virtuous one.
Apart from equity, governments have so far provided a massive $8.9 trillion to
banks through lines of credit, asset purchase schemes and guarantees . You
might think that's more than enough. But the IMF estimates that this is less
than one-third of their needs. Bank deposits will grow with GDP, of course,
providing them with some cash for lending. But the banks also need sums for
repaying their old obligations. The refinancing gap of banks, the IMF
estimates, will rise from $20.7 trillion in late 2008 to $25.6 trillion in
2011. The danger is that they will meet this by slashing future lending.
The sums needed for rekindling the world financial sector are frighteningly
large. But the US and European public is already rebelling against providing
more taxpayer money to rescue bankers, who are reviled as crooks and thieves.
The culpability of the bankers is beyond question, but they have also suffered:
the billions they got in stock options have become largely worthless with the
stock market crash. However, if the public refuses to allow governments to pour
additional hundreds of billions into rescues , then the global financial system
may be starved of essential capital. And if so, the negative feedback loops
will continue, and the recession too.
Now, some economists like Michael Mussa disagree strongly with the IMF. They
give historical examples of economies recovering despite little or no recovery
in bank credit. Once confidence soars, that alone can spark fresh production
and credit , a virtuous cycle. Optimists like Mussa and Surjit Bhalla predict a
V-shaped recovery. I myself tend towards pessimism. Let's hope for the best,
but prepare for the worst.
http://economictimes.indiatimes.com/articleshow/4477792.cms?flstry=1
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