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KAUTILYA
Goldilocks
Loses Sheen
After
an unprecedented 114-month economic expansion, America will slow down
By
Jairam Ramesh
Since
the mid-1990s, the US economy came to be called the Goldilocks economy.
Macroeconomics appeared perfect: just the right temperature of the porridge
(economic growth), just the right size of the chair (low inflation) and
just the right size of the bed (declining unemployment). Now, however,
Goldilocks may well be losing her shine.
The US economy's
performance since 1992 has been unprecedented. A nine-and-a-half year
economic expansion took place. Following the "stagflation"(growth
stagnation and galloping inflation) that marked the 1970s, the 1980s were
a growth period for books and articles that predicted America's decline.
The 1991-92 recession seemed to confirm that impression. But then in a
truly spectacular turnaround, the US economy rewrote all macroeconomic
theories. Not only did it have a boom period longer than usual under a
normal business cycle, it demolished the inflation-unemployment trade-off.
Economists
call this trade-off the non-accelerating inflation rate of unemployment
(NAIRU). Before the golden 1990s, America's NAIRU was estimated at around
6 per cent. But in the past decade, this has fallen to probably 4-4.5
per cent, meaning thereby that you can have a low level of unemployment
with a low level of inflation. This stunning macroeconomic record is,
according to the guru-Alan Greenspan, chairman of the US Federal Reserve
Bank-himself, the outcome of the "new" economy. Other economists
like Robert Gordon take a more sceptical view of the productivity spurt
of the mid-1990s. The Fed also estimates that the "wealth effect"
created by escalating stock prices has added around a percentage point
to GDP growth over the past four-five years with one in two American households
now hooked on to the stock market in one form or the other.
2001 will
certainly see a deceleration of growth in America. There is a view that
while the "new" economy made the upswing possible, it will also
affect the nature of the downturn-the decline could deepen and recovery
speeded.
Fears of
an actual recession which is defined as two consecutive quarters of negative
GDP growth are perhaps exaggerated. A more realistic assessment is that
the US economy may have a relatively "soft" landing this year
and end up with 2-2.5 per cent GDP growth as compared to 5 per cent registered
in 2000 and 4.5 per cent averaged in the past four years.
With Europe
showing modest growth and Japan totally in the doldrums, America has become
the locomotive of world growth-estimates are that one-third to one-half
of the world GDP growth is contributed by the US alone. America's global
influence is transmitted through five main channels-trade, commodity prices,
exchange rates, interest rates and capital flows.
A slowing
down of such a magnitude will impact on Canada and Mexico the most. Some
East Asian countries which depend on electronics exports to America will
also be seriously affected, although China may not suffer as much as say,
Malaysia or South Korea, since its export basket is more low-tech. India
is unlikely to be affected.
Oil prices
are expected to remain at moderate levels, barring a flare-up in the Middle
East which can never be ruled out. Oil prices hovering in the range of
$22-25 a barrel will clearly benefit us although depressed prices of other
commodities could be to our disadvantage.
The dollar
will most likely weaken against the euro enabling a euro-dollar parity.
This will help our exports to Europe. China whose currency is fixed to
the dollar will also gain, thus making its exports even more competitive.
International
interest rates will, in all probability, decline. This will mean lower
borrowing costs for Indian companies abroad and it will also put downward
pressure on domestic interest rates-something that is urgently required
to kickstart a new wave of investment.
If American
stockmarkets are tepid and bond yields stay low, then we can expect greater
inflows of portfolio investment. But at a time of all-round negative sentiment,
there might well be a "flight to safety" which means funds flowing
back to the US. There is also the matter of correlation with the Nasdaq.
Among all emerging markets, India has the fifth highest degree of correlation
after Mexico, Brazil, Poland and Hungary. The extent of correlation, as
reported recently in The Economist, is close to 0.75 with 1 being the
perfect value.
All in all,
2001 may see a world economy growth of 2-3 per cent. How India fares will,
however, be dependent entirely on what it does at home. Some analysts
are predicting a higher growth for us this year. That is eminently within
our grasp but if and only if privatisation transactions take place, interest
rates are cut and reforms by implementation-not reforms by announcements-are
stepped up.
(The
author is with the Congress party. These are his personal views.)
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