I am not sure how bad growth numbers will be for 2012. Europe certainly looks wobbly with a mild recession having set into both the core and the periphery. Germany managed to post robust numbers in the past because of its strong trade links with Asia, particularly China. But with Asian growth looking all set to moderate on the back of softer numbers from China, that support is likely to disappear.
European banks will continue to take a hit on their balance sheets owing to their exposure to sovereign debt. Thus, haircuts on their bond portfolios in the event of “managed default” by the likes of Greece, and marked-to-market losses on the back of rapidly escalating yields on peripheral debt, will erode capital — and, therefore, banks will continue to de-leverage. So, credit shortage could become a serious handicap for growth in the region. Besides, bailout packages continue to insist on fairly severe austerity for the recipients, which, in turn, will feed through to slower growth. The market consensus for euro zone growth in 2012 is incidentally 0.5 per cent; I won’t be surprised if we end up getting a negative print.
India seems all set to decelerate further and a sub-seven per cent growth in 2012-13 seems eminently possible. Of the lot, the US seems relatively better off with some data points looking occasionally encouraging. The median forecast for US growth for 2012 is two per cent; this is certainly low in an absolute sense, but is somewhat robust compared to Europe. The problem in the United States remains a combination of political brinkmanship (that will keep the course of fiscal policy uncertain) and the persistent sluggishness in the housing market. Our analysis of housing starts data and GDP growth in the US between 1951 and 2010 shows that the housing market has been either a strong leading or a coincident indicator of growth. Thus, unless the drums start to roll again in the residential property market, any significant recovery might fail to make an appearance.
Let me list some specific concerns or questions for 2012. First, how low could China go? Could growth find a floor at eight per cent or so, or will there be a sharper “hard landing”? Will the housing bubble in China finally pop? I have a lot of faith in China’s policy makers’ ability to prevent a full-blown slowdown. They are known to be nimble and have the tools (including quantitative controls on credit) to fight the slowdown. In short, I am not quite willing to paint a doomsday scenario for the Asian giant.
Second, I am deeply convinced that the euro is severely overvalued. The last time my colleagues ran a “fair value” model for the currency, they got a number of about 1.21 to the US dollar. Thus, a correction in the currency is overdue and is critical to recovery in the region. The question is: How will this happen? Could it be a relatively smooth process that will ride on policy rate cuts and liquidity infusion by the European Central Bank? Will it instead be driven by another upheaval in the region, which in extreme circumstances could lead to the exit of a couple of member states? I am taking the middle ground on this one. Some more turmoil seems inevitable, but a combination of fiscal props (through an expanded central stabilisation facility) and a more pliant central bank that combines rate cuts with a buy-back of dodgy sovereign bonds might just keep the extreme scenario at bay.
I might not be certain about growth for the coming year, but I am reasonably sure of the fact that we have another flood of liquidity coming our way. Central banks seem set to either reverse their aggressive monetary stance or actually start cranking up their money-printing machines. The coordinated action last week by six central banks to offer cheaper short-term credit lines to banks, and the Chinese central bank’s decision to slash reserve requirements, could just be the tip of the iceberg; more easing is due. The markets are actively pricing in the likelihood of another round of quantitative easing by the Federal Reserve, perhaps focused on mortgage-backed securities. The Reserve Bank of India (RBI) is likely to stay on hold for now, perhaps cut the cash reserve ratio (CRR) and contemplate cuts in policy rates early in the second half of 2012.
I was pleasantly surprised by how sharply financial markets responded to the liquidity measures announced last week and the prospects of more to come. The rally in the domestic stock markets last Friday, to take an example, was fuelled almost entirely by the rumour that the RBI was all set to cut the CRR that evening. Thus, 2012 is likely to be a year when financial markets will be caught between the crosswinds of easy liquidity and slowing growth. My forecast is that ultimately the anxieties over a persisting slowdown in the global economy will get the upper hand. However, markets seem to be suffering from “gloom fatigue”, and, in the near term, could perk up at the slightest whiff of liquidity. Therefore, a rally in all asset classes sometime in the first half of 2012 seems quite likely. That might be an opportunity for beleaguered investors to take Woody Allen’s advice: take the money and run.
The author is chief economist, HDFC Bank