Wed, Jan 19, 2011 - Page 9 News List

Potential global risks
and reward in 2011

Developed economies are recovering at a sluggish pace, while those in emerging nations are jumping ahead in a rapid V-shaped recovery

By Nouriel Roubini

Illustration: Mountain People

The outlook for the global economy this year is, partly, for a persistence of the trends established last year. These are: an anemic, below-trend, U-shaped recovery in advanced economies as firms and households continue to repair their balance sheets and a stronger V-shaped recovery in emerging-market countries owing to stronger macroeconomic, financial and policy fundamentals. That adds up to close to 4 percent annual growth for the global economy, with advanced economies growing at about 2 percent and emerging-market countries growing at about 6 percent.

However, there are downside and upside risks to this scenario. On the downside, one of the most important risks is further financial contagion in Europe if the eurozone’s problems spread — as seems likely — to Portugal, Spain, and Belgium. Given the current level of official resources at the disposal of the IMF and the EU, Spain now seems too big to fail yet too big to be bailed out.

The US represents another downside risk for global growth. This year the US faces a likely double dip in the housing market, high unemployment and weak job creation, a persistent credit crunch, gaping budgetary holes at the state and local level, and steeper borrowing costs as a result of the federal government’s lack of fiscal consolidation. Moreover, credit growth on both sides of the Atlantic will be restrained, as many financial institutions in the US and Europe maintain a risk-averse stance toward lending.

In China and other emerging-market economies, delays in policy tightening could fuel a rise in inflation that forces a tougher clampdown later, with China, in particular, risking a hard landing. There is also a risk that capital inflows to emerging markets will be mismanaged, thus fueling credit and asset bubbles. Moreover, further increases in oil, energy, and commodity prices could lead to negative terms of trade and a reduction in real disposable income in net commodity-importing countries, while adding to inflationary pressures in emerging markets.

Moreover, currency tensions will remain high. Countries with large current-account deficits need nominal and real depreciation (to sustain growth via net exports while ongoing private and public-sector de-leveraging keeps domestic demand weak), whereas surplus countries (especially emerging markets) are using currency intervention to resist nominal appreciation and sterilized intervention to combat real appreciation.

This is forcing deficit countries into real exchange-rate adjustments via deflation — and thus a rising burden of public and private debt that may lead to disorderly defaults.

Furthermore, several major geopolitical risks loom, including military confrontation between North and South Korea and the lingering possibility that Israel — or even the US — might use military force to counter Iran’s nuclear weapons program.

There are also the political and economic turmoil in Pakistan and the risk of a rise in cyber-attacks — for example, in retaliation for criminal proceedings against WikiLeaks.

In the US, slower private-sector de-leveraging — given the fiscal stimulus from the extension of unemployment benefits for 13 months, the payroll-tax cut, and maintenance of current income-tax rates for another two years — could lull policymakers into assuming that relatively large fiscal and current-account imbalances can continue indefinitely. This could generate financial strains over the medium term and protectionist pressures in the short term.

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