Which way will the economy recover?

Sandip Sabharwal - Uncategorized - Which way will the economy recover?

PART 1 – Brief global overview

Over the last few months we have had various forecasts on the way the global economy will grow and stabilize following the sharp downturn in growth over the last one year. There have been various forecasts from professional economic forecasters, IMF etc. etc. on the shape and likely speed of recovery. The various shapes of recovery which have been talked about are as follows

V shaped recovery – Here the economy falls off very fast and then recovers also very fast
U shaped recovery – Here the economy falls off, remains low for a period of time and then recovers at a rapid pace
L shaped recovery – Here the economy falls off and then does not recover for an extended period of time
W shaped recovery– Here the economy after having fallen off recovers due to the various fiscal and monetary measures, however is not able to sustain itself and falls off again before finally recovering.

My view is that trying to fit in the recovery into these shapes is an exercise in simplicity and the actual recovery will have various facets to it. I think the recovery process can be broken down into three major geographical (economical, political whatever) segments of the world in terms of countries.

Western Economies & Japan– These are the countries where there is a big structural issue in the economies where a large part of the economic growth was dominated by consumer spending and here most of the countries have lost their advantage in manufacturing to a greater extent. The financial system of these economies has collapsed and the saving rate is very low. (Unlike some countries like Germany). Japan although not a Western economy also faces issues because of its poor demographics and high export dependence. Here the recovery process is likely to be an L shaped on in my view. Although the financial institutions seem to be settling down due to the unprecedented interventions by the governments and monetary authorities, the issues of reduced competitiveness, high unemployment, low growth in real incomes for an extended period of time as well as low saving rates is likely to impact economic growth. In these countries recent economic numbers also reflect a reduced pace of fall rather than an actual recovery. The up tick in consumer spending due to tax reductions and low inflation also might not continue if a number of commodity prices keep on moving up as they have over the last few months. For example a $ 1 per barrel increase in oil prices reduces disposable incomes in the USA by nearly $ 8 billion. The fall off in these economies has been almost verticle, but the recovery will be a very very slow process.

Other export dependant economies with a lower scope to boost domestic demand – These economies which would include lot of ASEAN countries would again see a period of low par growth with recovery starting as most Developed country economies stabilize. Since these countries are still developing there is a potential to boost consumption as well as infrastructure spending to boost economic growth. Saving rates in these countries are high and financial systems relatively stable. As such there is likely to be a U shaped recovery in these countries, however the pace of up tick will be much smaller than the pace of the downtick. Similarly lot of gulf countries are getting impacted due to low oil prices and so are other commodity export dependant economies like Australia, Latin American countries etc.. For these countries China will be more important than the West and given the imminent collapse of the US dollar, commodity prices should stabilize significantly above the lows of 2008. However a big bull run in commodities will still be more than two years away.

Countries that are domestic oriented or can boost domestic demand- Among larger countries India is in the first category and China in the second. Here I believe that the recovery will be in the shape of a tick mark (not a V shaped one) for the near term where there will be a slow and steady recovery which will continue. A combination of strong financial systems, high savings rate, greater government spending, low inflation and low interest rates will boost the growth of India and China. India is much better placed than china in the medium term due to its better demographics and greater need to develop infrastructure. There is still huge potential to invest and earn good money due to the shortage of infrastructure in sectors like power, roads, ports, urban infrastructure etc. in India. Easing global liquidity as well as lower interest rates on forex borrowings will lead to better fund raising potential for companies wanting to invest into these segments. The pace of recovery is only expected to gather pace rather than again fall off in these countries.

In the second part of the article I will touch on how I see India in specific recover and what it portents for the markets.

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