Drag on world economy

The US fiscal position is worse than that of major European triumvirates, Germany, France, and the United Kingdom.

The G-20 Meeting for the Heads of Governments will be held at Toronto, preceded by a meeting of the Finance Ministers in Busan, South Korea. The G-20 members, discussed managing common challenges in 2009, and the spread of the budgetary stimulus to bring the economy back to shape, but now, the focus has shifted on sustainable public finances, and the need for measures to deliver fiscal sustainability, while the emphasis will be identifying steps which would strengthen the private sector recovery. Retrenchment is going to be a major plan which will phase the second leg of stimulus- phased exit strategies. Southern Europe is feeling the heat on the debt markets, its needs to soothe this vulnerable area. Britain is over cautious as it is anticipating ‘years of pain ahead’ while Germany is seized of the $ 100 billion retrenchment plan while the French followed it by outlining $ 80 billion retrenchment plan.
The developed countries face a homologous situation, with dismal budgetary deficit averaging 9% of GDP in 2009, while the prospect of public debt ratios rising from roughly 70% of GDP prior to the crisis to more than 100% of GDP in 2015. The economists feel that to reach 60% debt ratio in 2030 would require a budgetary adjustment of almost 9% points of GDP on an average between 2010 to 2020. Though this is not impossible it is highly improbable and without precedent.
How to make adjustments? To make it real, one has to have exhaustive economic brain. In the past, some countries have enjoyed tearless consolidation due to launch of retrenchment programme, and with the long-term interest rates dropped, causing a decline in private savings, and a surge in exports, exchange rate depreciation, or all of these at the same time. But conditions today are characterized by low interest rates and high private debt, so none of these may help, except possibly for exchange-rate effects. Indeed, depreciation has already started for Europe, and many consider the euro's fall, from $1.5 in late 2009 to $1.2 in recent days, sufficient to offset in the short term the retrenchment's negative impact on growth. In the Indian perspective, large sideways movement in the value of the Rupee against the euro has led to severe problems. The evolving situation in the Euro zone does not inspire confidence. There are indications of buyers in the EU region going slow in placing their orders. There are also cases where the Indian Companies have been asked to withhold consignments. All these indicate that the Second phase of global recovery will be slower as compared to the first phase having a bearing on the pace of expansion of global trade. But this can work only as long as the US does not follow suit and continues to serve as consumer of last resort. This may not happen. More importantly, increasingly nervous bond markets will at some point start questioning the sustainability of US public finances. The US fiscal position is no better than that of major European countries EU is fragmented, so markets started off by questioning the solvency of the weakest countries within it, and because Europe does not benefit from a safe-haven effect that it was the first to suffer the pressure. Fortunately, the public-finance situation is entirely different in the developing world, which in some cases has been hit by capital flow reversals stemming from the collapse of world trade, but does not face an internal adjustment challenge. The fiscal challenges for them are of much lower degree than in the advanced world. So, what if Europe and the US both enter a phase of prolonged budgetary adjustment while the emerging world stays on course? What if the divergence between the North and South within the G-20 widens further? Present state of world economy may cause spider web growth or a significant drag on world growth. Even though emerging economies may sustain domestic markets and re-orient its export strategy by exporting more to developing countries other than EU, USA and Japan, the volume and content would be miniscule so as to have a base effect on world growth. Growth differential between emerging and advanced countries will widen intensifying flows of capital and labour to the developing world. But the developing world will not be able to sustain them on the medium to long term. Developed countries would need monetary support which would necessitate keeping low interest rates for years together, while the monetary needs of developing countries will be radically different. This will make fixed exchange rate links crack under pressure, as the same monetary policy cannot be appropriate for both the developing and developed regions.
Double dip growth was savaged by the developed and developing countries through sound, stymied and theoretical economic monetary policies. But as the world slowly turned to ‘V’ shaped growth with short and sharp contradictions, while rapid and sustained recovery is no where on the cards. G-20 needs to face the challenges, divergence in the new context of different pictures of movement of economy in the developing and developed G-20 nations. This will be a major test of resilience at the same time to demonstrate effectiveness in the Catch 22 situation in the passing phase of global economy. The outcome of the Toronto conclave will determine the road the economy will take.