India must keep in mind US recovery will be rocky
On the face of things, the steady rise in US GDP growth, from 0.4% in Q4 2012 to 1.8% in Q1 2013 despite the dramatic increase in contraction of government expenditure—by 7% in Q4 2012 and 4.8% in Q1 2013—is an encouraging sign of the steady progress in US growth. What has made this possible is that, thanks to the great support provided by the government to the housing market, housing prices have risen a tenth over the last year and, with household wealth rising, personal consumption expenditure’s contribution to GDP growth has been positive for the last 13 quarters and, after a blip in Q1 2012, it has been gaining strength in the last four quarters. While volatile, private investment’s contribution to GDP growth has also been positive for the last 8 quarters.
The problem, as the IMF’s latest Article IV consultations with the US shows, is that the progress is likely to be quite volatile in the period ahead. We have seen some very intense periods of volatility in the past when GDP collapsed from 4.1% in Q4 2011 to 2% the next quarter, or when it fell from 3.1% in Q3 2012 to a mere 0.4% the next quarter. Some part of this has been due to inventory spurts and sharp changes in government expenditure, but the danger the IMF is talking about this time around is something the world got a glimpse of in May when, in response to Fed Chairman Ben Bernanke’s statement which suggested the Fed would be winding down its bond buying programme soon, there was a flash crash in most global markets. While the Fund’s economists expect, like most others, the drag of lower government expenditures to be made good by greater private consumption growth—largely made possible by an accommodative monetary policy—they caution that the US future path can be quite rocky. As in much of the rest of the world, US financial markets will make very jerky adjustments—going too much one way and then correcting by going too much the other—to the Fed’s taper. With bond yields going up, and in many cases very sharply for short periods of time, this will affect investments. More important, once interest rates start rising and the liquidity tide goes out as it were, US banks could be staring at the impact of what the IMF calls covenant-lite loans—basically loans made without too much thought about the underlying asset quality, thanks to the surplus liquidity made available by the Fed. And there is the impact of rising yields on bank balance sheets in terms of mark-to-market bond losses. In other words, the Fed’s taper, whether it takes place at the end of the year or in the middle of next year is going to lead to very sharp bouts of volatility. Indian policymakers have the choice of letting the market be or intervening with ultra-aggressive tightening as they are doing now. Either way, the impact on the economy, more so since there will be a new government at the helm then, will be considerable.