Why 2018 will not be an encore of 2008

The structural issues that caused the Second Great Depression of 2008 crisis still lurk in hidden crevices. To pessimists, it’s déjà vu revisited, as some signs are similar to the pre-existing conditions that built up to the 2008 meltdown. That is because we continue to live in a leveraged world where consumer spending exceeds personal earnings, and where sovereign debt to GDP ratios remain high. With governments borrowing staggering amounts, the ratio of global debt as a share of economic output stands at 40 per cent higher than it was on the eve of the 2008 crash, according to the Bank for International Settlements. Call this phenomenon “apocalypse deferred”. Despite better regulatory checks and balances put in place by central banks, Circa 2008 is an event that can come back to haunt the global economy anytime, because “the world has tried to borrow its way out of a debt crisis”.

While all major economies clocked synchronised GDP growth in 2017, the good news rested on policymakers over-stimulating financial markets with liquidity. Financial markets are way ahead of corporate earnings or the real economy, especially in India, and do not reflect authentic economic performance. Should and when the global asset bubble burst, the slide into recession will be steep, and the stream of good data can turn into a reverse momentum. Because since the last decade, the monetary stimulus has been “force- feeding” a bubble in the offing.

With unemployment rates touching close to a 40-year low in the US and developed economies, the buoyant trend in the labour market puts upward pressure on wages which drives inflation. Easy money from central banks printing more money and holding interest rates low has made investors use the cheap cost of capital to drive up asset classes back into bubble territory, reminiscent of 2008.

However, seldom has good news bought stock markets down, as is seen since the last few weeks when US President Donald Trump tweeted: “In the ‘old days’, when good news was reported, the stock market would go up. Today, when good news is reported, the stock market goes down. Big mistake, and we have so much good (great) news about the economy!” The Trumpism best describes the confused reaction of global stock markets, because the recent reversal cannot be attributed to any banking collapse, nor a terrorist-driven panic or a geopolitical disaster. A sustained bull-run followed by a healthy overdue correction could also portend that the world economy has finally matured and transited from the prolonged 2008 crisis, and with multiple regulatory safeguards in place, is in a phase of a long awaited “post-Lehman rebound”. Because a sell-off that was triggered by the good economic news of wages of the average American worker having grown by 2.9 per cent during the year to January, the fastest rate of employment growth since the recession, should not have caused a reversal. When labour has bargaining power, wages rise, having a spiralling effect on inflation. So paradoxically, what is perceived as a shock for the markets is actually overdue good news for the rest of the economy, as jobs and consumer spending only grow when industry revives, both factors feeding off each other to produce a virtuous economic cycle.

The American economy, despite its protectionist trade policies since the Trump era is important because the US was the epicentre of the 2008 crisis, and their policies have a cascading effect, because markets as also globally economies take their cues from the US. When inflation is low in the US, it provides a leeway for the Federal Reserve to keep interest rates low. The challenge is every time there are murmurs of the central bank raising interest rates. It has spooked markets across the globe, as it would raise the cost of capital, and money would migrate to safer asset classes, exiting stock markets abruptly because higher interest rates would end the cycle of ultra-cheap borrowings. That cascade then starts spiralling down to the “real economy”.

After the Lehman crisis, low interest rates and quantitative easing (QE) were curative and necessary because had central banks not been supportive with infusing liquidity in 2008, payment systems would have stalled, fuelling panic. But the prolonged monetary policy of easy money should have been phased out years back, as persisting with what was once a contingency measure now risks the restart of a vicious boom- bust cycle all over again.

Asset bubbles generally precede global recessions. There has been a 29 per cent rise in the Sensex in one year. The Economic Survey attributes the boom to demonetisation, as the note ban played a major role in bringing back slush money into the formal economy which had to be invested, as also investors who had previously parked their savings in real estate and bullion moved their capital into stock markets. Households began investing more in stocks and mutual funds in preference to real estate, fixed deposits or gold. The sharp and sustained rise in equity despite weak corporate earnings is attributed to this gush of capital by retail investors for the above reasons. Also in India with lowering fixed deposit rates, fixed income returns do not yield inflation-plus earnings, especially important for the risk- averse investors and pensioners. So the retail investor has in a way been forced to restructure his portfolio and park a certain amount of savings in the markets.

Is this then a real recovery or just a short-term pause before difficult times return? Historically, when there is a real transition into prosperity, everybody feels it. Neither can leaders nor the investor get delusional that all is well, as there are multiple variables in the offing in 2018 with general elections next year, oil prices inching up, and the effects of a good or bad monsoon unpredictable. Besides, in 2017 when ambient economic conditions were conducive, India underperformed and sat out of the global growth cycle, raising scepticism on how we would fare in the event of a global downturn?

CEOs’ optimism is more cautious regarding their own organisation’s revenue growth prospects before fiscal 2019. Besides, India is integrated with the global economy, which means economic and financial policies and taxation levels cannot be out of sync with advanced economies. The integration is evident as seen in 2016-17 cross-border financial flows were 47 per cent of GDP compared to a meagre 12 per cent in 1991. Investors begin to migrate cash to destinations like Singapore to offset higher costs of India’s regulatory environment when taxation is hostile or unpredictable. Besides, despite government infusing crores to recapitalise banks, NPAs have been mounting and the depth and scale of the recent PNB heist exposes the faultlines of India’s banking system, with wilful defaulters having siphoned out '1,60,000 crores from public sector banks. The only assurance is that the RBI has never let public sector banks fail. While market upswings of the past three years reflect optimism about the world economy, India is still in a revival and consolidation mode after its self-inflicted, albeit transient blows of structural reforms. All said and done, despite the macro or micro negatives, 2018 will not be 2008, so we must view the transient phenomenon as blips in the larger context of global revival.

Bindu Dalmia is an author and columnist based in Delhi