Policy maker’s hands are tied and that’s the best part
This time around, policy makers cannot do much. There are talks about a global coordinated action to bring about order in financial markets, which are moving all over the place on worries on the state of the global economy. However, even if the G-20 or G-7 countries meet and try for a concerted action, it will not match the scale of the action taken in 2008, post the credit crisis. This is the best thing that can happen to economies and markets. Economies and markets without policy maker’s intervention will do much better in the long run as one ugly hand is taken out of the pot.
The US credit rating has been downgraded from AAA to AA+ with a negative outlook by the rating agency S&P. The rating agency wanted more from the US government on the fiscal front, which the government did not deliver when the debt ceiling was raised. US government debt is expected to rise to 79% of GDP in 2015 from 74% of GDP in 2011. The US provided massive stimulus to the economy post 2008 crisis with tax cuts and other benefits. The US Federal Reserve (Fed) too chipped in by bringing down interest rates to all time lows and expanding its balance sheet to record highs.
The US economy is living with unemployment rates of 9.1% (down from 9.8% levels in 2010 but still much above last ten years average of 6.4%). US GDP growth forecast is cut to 2.7% to 2.9% for 2011 against previous estimates of 3.1% to 3.3%. Interest rates are at all time lows. In this scenario the US government is forced to cut fiscal deficit due to its high debt. The Fed cannot do much except buy government bonds, but the last two bond purchase program (QE1 and QE2) has not had the desired effect and there are doubts on the efficacy of QE. (Quantative Easing).
The US economy now will have to fend for itself.
The situation is similar with the rest of the world. Euro zone is in a sovereign debt mess with countries from Greece to Italy seeing the negative effects of high debt on its cost of borrowing. Borrowing costs for indebted countries in the Eurozone has gone up by 300bps to 2000bps depending on the finances of each country. The ECB (European Central Bank) is caught between rising inflation (inflation in the Eurozone is above ECB target of 2%) and worsening sovereign debt. European governments and the ECB cannot do much to improve market sentiments or bring about economic growth.
The Eurozone economy will have to fend for itself.
India has it problems. Inflation is the effect of the government and RBI pump priming post 2008 crisis. Government ran up fiscal deficit to 6.8% of GDP from 4% of GDP while the RBI cut policy rates by 500bps and bought government bonds to add liquidity into the system. Inflation moved up to double digit levels on the back of the pump priming. GDP growth forecast for 2011-12 is at 8% levels down from growth levels of 8.6% in 2010-11. GDP growth is expected to come down below 7.5% by some economists.
The government cannot increase spending while the RBI cannot cut rates or add liquidity into the system to bring about economic growth. The Indian economy will have to fend for itself.
The question is whether the private sector can bring about economic growth. The answer is yes. Private sector in the face of adversity pulls up its socks and does the right things. It innovates to improve productivity. It brings down costs, which will bring down inflation. It uses its cash efficiently. The economy benefits and so do stakeholders.
The economies in the US, Eurozone and India are not down in the dumps. The forecast is still of GDP growth and not recession. US is adding jobs, German unemployment is at 20 year lows while India is forecast to grow at over 7% levels.
Lack of government involvement coupled with private sector pulling up its socks will create a strong foundation for future economic growth. The best way to participate is to buy equities.
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