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China Slowdown, A Healthy Indicator

China  Slowdown, A Healthy Indicator
Much against the common perception, the Chinese Finance Minister Lou Jiwei described the slowdown in China’s economy as a healthy process. However, he said policy makers needed to manage it carefully. According to him, “slowing of China’s economic growth is a healthy process, but it is a sensitive period. The Chinese government must make accurate adjustments, keeping the economy within a predictable space while continuing to promote internal structural reforms.”

Jiwei, on his way to attend the IMF crucial meet on world economic crisis, cautioned the US Federal Reserve against raising the rate of interest and observed Western economies are still too weak to cope with Fed rate rise. The IMF feared that an interest rate increase from the US Federal Reserve is a likely catalyst for the crisis in emerging markets.

Jiwei held that US Federal Reserve has ‘global responsibilities’ to ensure that monetary policy is kept loose. A slow recovery of western economies means the US Federal Reserve should not raise interest rates yet, according to the Chinese finance minister.

In fact the IMF has warned of new financial crisis if interest rates rise. The IMF said that the financial crisis that came to a climax in 2008 had its origins in the developing world. From Mexico in 1994 to Thailand in 1997 the story was the same. The financial crisis eventually shifted to the core of the developed market from the periphery of the global economy. In the present situation the crisis of the developed market was spilling to the developing economy.  Now the focus of the IMF is back on the risks presented by the emerging world.

About the global economic situation Lou holds the problem was not with developing countries. “Rather, it is the continued weak recovery of developed countries” that’s hindering the global economy. While Lou welcomed the structural reforms in Europe as a positive development, he said “Developed countries should now have faster recoveries to give developing countries some external demand.”
Jiwei said developed economies were to be blamed for the global economic malaise because their slow recoveries were not creating enough demand. He said it was imperative that US “should assume global responsibilities” because of the dollar’s status as a global currency. Significantly Jiwei’s observation came as Asian shares extended an impressive 11 per cent rise in September. While Beijing has generally refrained from launching widespread stimulus measures to boost slowing growth, it has resorted to a steady drip-feed of measures in recent weeks to support various sectors.

Interestingly ignoring the IMF view and global feeling, the Federal Reserve is all set to start raising rates in December, but monetary tightening will be motivated by concerns about financial stability, not inflation.  However on his part the US Federal Reserve chair Janet Yellen said the interest rates have been left unchanged amid persistent worries about the global economy and financial market volatility. According to him Fed’s decision confirmed that it is not indifferent to international financial stress. He retorted, So why did the markets and media behave as if the Fed’s action – or, more precisely, inaction – was unexpected?

Fed is also contemplating to bring about some structural change in its interest policy as almost all modern economic models, including those used by the Fed, are based on the monetarist theory of interest rates propounded by Milton Friedman in his 1967 presidential address to the American Economic Association. Friedman’s theory asserted that inflation would automatically accelerate without limit once unemployment fell below a minimum safe level, which he described as the “natural” unemployment rate. After some years Friedman’s natural rate theory was replaced with the less value-laden and more erudite-sounding “non-accelerating inflation rate of unemployment” (Nairu).  Nevertheless, economic analysts hold that Canada and Australia feel the squeeze in wake of Chinese economic slowdown.  Iron and oil producers proved resilient during the crash of 2008-09 but are now struggling as commodities prices decline. It is widely believed that the impact from China was not just limited to Asia-Pacific but also Latin America and in particular Chile. Earlier the International Monetary Fund said the weak commodity price outlook could subtract one percentage point annually from economic growth in commodity exporting countries like Australia over the next two years. Growth in Australia slowed to just 2 per cent at the end of the June quarter, well below its long-term average of 3.25 per cent.

Meanwhile Andrew Haldane, the Bank of England’s chief economist, has warned that a fresh meltdown in emerging markets could form part three of a crisis trilogy following the near-death of the banks in 2008 and the threat to the Eurozone.

As in the 1990s, there has been excessive borrowing, much of it in hard foreign currencies. Debt exposure is particularly high in those sectors - construction and energy - that are vulnerable to the ups and downs of the economic cycle.  The IMF fears that there could be a wave of corporate failures as western countries begin the process of returning policy to a more normal setting. Financial markets think this will begin later this year with an interest rate increase from the US Federal Reserve, a likely catalyst for the crisis in emerging markets the Fund clearly fears. After conclusion of its annual meeting in Lima the IMF cautioned the central bankers that the world economy risks another crash unless they continue to support growth with low interest rates; uncertainty and financial market volatility have increased, and medium-term growth prospects have weakened.

The IMF’s managing director, Christine Lagarde, said there were risks of “spillovers” into volatile financial markets from central banks in the US and the UK increasing the cost of credit. The IMF has also urged Japan and the Eurozone to maintain their plans to stimulate their ailing economies with an increase in quantitative easing.

The IMF is worried not because it has shaved its growth forecast for 2015 for the second time in six months but for the reason the global economy continues to under-perform. The IMF has over-estimated global growth by one percentage point a year on average for the past four years.

The IMF has also come out with the warning that the weak recovery in the west risks turning into near stagnation after cutting its global economic growth forecast for the fourth successive year. It predicted expansion of 3.1 per cent in 2015, 0.2 points lower than it was expecting three months ago and the weakest performance since the trough of the downturn in 2009.

The IMF’s world economic outlook (WEO) predicted the US would have the strongest growth of the leading G7 industrial nations in both 2015 and 2016, at 2.6 per cent and 2.8 per cent, respectively. Britain is expected to be the second-fastest growing G7 nation, although output growth is predicted to slow from 2.5 per cent to 2.2 per cent. However none of the other G7 countries – Germany, France, Italy, Japan and Canada – is predicted to post growth as high as 2 per cent in either 2015 or 2016.

Emerging market economies such as China were the main source of growth in the immediate aftermath of the 2008-2009 slump, but the IMF said the outlook was weakening, with growth projected to decline from 4.6 per cent in 2014 to four per cent in 2015 – the 5th annual decline in a row. China’s growth is expected to match earlier IMF forecasts but recessions in Brazil and Russia are now on course to be worse than previously estimated. 
Arun Srivastava

Arun Srivastava

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