 "Financial volatility will not derail global economy: Raymond W McDaniel, Jr")
A prolonged period of financial volatility could affect the real economy in 2016 but India will still be the fastest growing economy in the G20 countries, says Raymond W McDaniel, Jr, president & chief executive officer of Moody's Corp, parent company of global rating agency Moody's Investors Service and Moody's Analytics, in an interview with Anup Roy. He says the sharp fall in emerging markets' currencies is not necessarily bad but there is a growing divergence between what the US Federal Reserve has predicted about rate cuts and what the financial markets expect. Both cannot be right and this could lead to a further round of financial markets volatility. Edited excerpts:
Many analysts are suggesting 2016 will be a volatile year for the world market and the situation could end akin to those during the crisis of 2008.
It's important to distinguish between financial market volatility and its effects on the real economy, with factors such as consumption and investment. So far, there isn't much evidence to suggest the volatility recently witnessed in financial markets is having a real economic effect. We also think banking systems around the world are stronger than in 2008, reducing the risk that volatility could result in financial instability. So, our core view is that financial market volatility will not derail the global economy, and 2016 is likely to see another year of steady but subdued global growth. Asia will continue to grow relatively strongly, while the emerging markets, more broadly, will see a further slowing in growth. India will stand out as the fastest growing economy in the G20.
How do you think a slowing in China will further affect the global stock markets, as oil prices have?
As China has been one of the main engines of global growth in recent years, contributing around a third of global Gross Domestic Product growth in the past five years, a slowdown there is bound to have implications for the global economy. Recent trends in financial markets and commodities likely reflect, among other things, pricing in the impact of slower growth in China. However, it's also important to remember that lower commodities prices, including oil, benefit consuming economies, and should act as a boost to growth. India is one country that has benefited from the lower oil price, for example in terms of its improved balance of payments position and lower inflation.
As for the slowing in China, we view this as an inevitable side-effect of the economic rebalancing their government began a little over two years ago. As long as the slowdown remains gradual and that progress in implementation of reforms continues, China's economy will in the long run be placed on a more sustainable basis. And, we see this as supporting future credit quality, though the adjustment might cause some short-term pain.
Do you expect a currency war?
The currency weakness we saw during 2015 was primarily due to emerging economies allowing their currencies to take some of the pressure of the reversal of capital flows and the growth slowdown. These policies contrast with the approaches adopted in Asia in 1997-98, when governments tried to defend exchange rates, at high cost to their economies. Flexible exchange rates allow one to preserve or mitigate the erosion of foreign currency reserves. So, the currency devaluations we have seen so far in Asia are not necessarily a negative development.
How are the global central banks going to react to the slowdown? And, do you expect the US Fed to go ahead with its rate hikes?
We expect to see continued divergence between those central banks still pursuing accommodative monetary policies - chiefly the European Central Bank and the Bank of Japan - and the Federal Reserve, now that it has started on a tightening trend. The Fed is responding to US economic data and prospects. As long as the US economy continues to perform reasonably well, we expect the Fed to remain on a path of gradual, measured tightening.
One risk for the global financial markets is the disconnect between the interest rate path the Fed itself predicts and that implicit path assumed by financial markets. The latter expect a much slower rate of tightening than does the Fed, and they can't both be right. If financial market participants need to adjust their expectations of US interest rates abruptly, this could lead to a further round of financial market volatility.
How is India doing, overall?
It is now the fastest growing major economy in the world. However, this has not translated into rising corporate profitability. And, there are still policy challenges related to meeting the fiscal and inflation targets. Nonetheless, India is less reliant on exports, commodities and external capital, compared to many emerging market peers. This supports its outlook - on a relative basis - in 2016, during which global trade, commodity price and financial conditions are likely to remain uncertain.
Do you see an improvement in India's ratings anytime soon?
The outlook on India's Baa3 rating is positive, highlighting our assessment that some positive developments could lead to an upgrade. Evidence of further progress in reforms that lead to sustained higher growth, feeding to improved fiscal metrics that could move the rating up.
Many analysts are suggesting 2016 will be a volatile year for the world market and the situation could end akin to those during the crisis of 2008.
It's important to distinguish between financial market volatility and its effects on the real economy, with factors such as consumption and investment. So far, there isn't much evidence to suggest the volatility recently witnessed in financial markets is having a real economic effect. We also think banking systems around the world are stronger than in 2008, reducing the risk that volatility could result in financial instability. So, our core view is that financial market volatility will not derail the global economy, and 2016 is likely to see another year of steady but subdued global growth. Asia will continue to grow relatively strongly, while the emerging markets, more broadly, will see a further slowing in growth. India will stand out as the fastest growing economy in the G20.
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That said, the risks to the global economy are weighted to the downside. Financial market volatility might continue as investors adjust to gradual increases in interest rates in the US, slower growth in China and lower commodity prices for longer. Although it isn't our core view, a prolonged period of financial volatility could begin to affect confidence and, thereby, feed through to the real economy.
How do you think a slowing in China will further affect the global stock markets, as oil prices have?
As China has been one of the main engines of global growth in recent years, contributing around a third of global Gross Domestic Product growth in the past five years, a slowdown there is bound to have implications for the global economy. Recent trends in financial markets and commodities likely reflect, among other things, pricing in the impact of slower growth in China. However, it's also important to remember that lower commodities prices, including oil, benefit consuming economies, and should act as a boost to growth. India is one country that has benefited from the lower oil price, for example in terms of its improved balance of payments position and lower inflation.
As for the slowing in China, we view this as an inevitable side-effect of the economic rebalancing their government began a little over two years ago. As long as the slowdown remains gradual and that progress in implementation of reforms continues, China's economy will in the long run be placed on a more sustainable basis. And, we see this as supporting future credit quality, though the adjustment might cause some short-term pain.
Do you expect a currency war?
The currency weakness we saw during 2015 was primarily due to emerging economies allowing their currencies to take some of the pressure of the reversal of capital flows and the growth slowdown. These policies contrast with the approaches adopted in Asia in 1997-98, when governments tried to defend exchange rates, at high cost to their economies. Flexible exchange rates allow one to preserve or mitigate the erosion of foreign currency reserves. So, the currency devaluations we have seen so far in Asia are not necessarily a negative development.
How are the global central banks going to react to the slowdown? And, do you expect the US Fed to go ahead with its rate hikes?
We expect to see continued divergence between those central banks still pursuing accommodative monetary policies - chiefly the European Central Bank and the Bank of Japan - and the Federal Reserve, now that it has started on a tightening trend. The Fed is responding to US economic data and prospects. As long as the US economy continues to perform reasonably well, we expect the Fed to remain on a path of gradual, measured tightening.
One risk for the global financial markets is the disconnect between the interest rate path the Fed itself predicts and that implicit path assumed by financial markets. The latter expect a much slower rate of tightening than does the Fed, and they can't both be right. If financial market participants need to adjust their expectations of US interest rates abruptly, this could lead to a further round of financial market volatility.
How is India doing, overall?
It is now the fastest growing major economy in the world. However, this has not translated into rising corporate profitability. And, there are still policy challenges related to meeting the fiscal and inflation targets. Nonetheless, India is less reliant on exports, commodities and external capital, compared to many emerging market peers. This supports its outlook - on a relative basis - in 2016, during which global trade, commodity price and financial conditions are likely to remain uncertain.
Do you see an improvement in India's ratings anytime soon?
The outlook on India's Baa3 rating is positive, highlighting our assessment that some positive developments could lead to an upgrade. Evidence of further progress in reforms that lead to sustained higher growth, feeding to improved fiscal metrics that could move the rating up.