Rate Cuts, Trusts, Banks and the Summer of 2001

Energy is the weak link in the gl= obal growth story

In little over a month from now we will be marking= the anniversary of the outbreak of the sub-prime outbreak and what a packed yea= r it has been. Little wonder that looking back one may be forgiven for thinking = that it spanned years, rather than just eleven months. There are clear signs of weariness in the market and media: Which directly derive from the mindset a= nd expectations of the present times, where we have got too used to instant information, communication and resolution. In many ways we have got much mo= re efficient and that includes the economic and market process and the art of managing it. But it still takes time for a systemic financial crisis to be worked out of the system, especially when the curious actions of the world’s leading central bank appear to have had the unintended consequence of fuelling an unprecedented boom in oil and many other commodi= ties – an unexpected side effect of the sub-prime financial crisis. <= /o:p>

For after all, what was the financial crisis basic= ally threatening? The answer is economic investment, business and consumer confidence and growth. The statement issued by the US Federal Reserve yeste= rday, spent 74 per cent of its word length on economic growth (too little on infl= ation, however, and that is a big part of the present problem). Now, if growth that is, aggregate demand, is threatened that ought to mean, given the available supplies, prices should decline. On the contrary, prices have surged. And don’t blame In= dia and China for this; both of these economies were growing much faster this time last y= ear when crude oil was $70 a barrel – half of the level this year. The US dollar is down by 13 per cent vis-à-vis the Euro, but that is no whe= re close to 50 per cent; and the decline in the greenback had more to do with = Dr. Bernanke’s monetary prescription than with any thing else. Most peopl= e in the world believe financial speculators have taken the ball from OPEC at $8= 0–90 per barrel and carried it to present levels; a minority denies that, citing demand-supply fundamentals. We shall find out before the year is out – but that will be of academic interest, since the reality is that oil is at $140/bbl and all kinds of commodities including corn, wheat and rice are at unprecedented highs.

This dangerous side-effect has had the consequence= of a massive outbreak of high inflation across the world, being particularly a= cute in developing countries where food is an important part of the consumption basket and where petroleum product prices had been kept down by either not taxing them or by providing a subsidy.

At one level, the high inflation rates are indeed = the delayed effects of the extremely rapid pace of growth that not just Asian, = but African and Latin American developing countries, as also the developed economies of North America, Europe, Asia and Australasia have been experien= cing over the past several years. It is not that inflation was absent between 20= 03 and 2007. It was there: China had a bout of it in 2004 and has it since the second half of 2007; we had one in 2004, 2006 and now. The US and EU had inflation at levels close to or exceeding the upper limit of their tolerance level and now well above this limits. Australia and New Zealand of course h= ave had high inflation which is why they have kept pushing interest rates up and up= . Resource utilisation levels, best measured in terms of unemployment was systematical= ly getting tighter in Europe and the US. Supply slacks in commodities – oil, met= als and so on – was being drawn down.

There was also evidence of tremendous productivity growth and clear gains from rising international trade. In one way the world was living dangerously by growing at a continuous pace at historically very high levels. In another way, the potential of reaching the benefits of grow= th to billions of people in the poorer parts of the globe was being realised i= n an unprecedented manner.

While the world clearly had got itself an operating framework for producing fast and well-distributed growth, it had not moved ahead consistently on a number of important issues. The most important of w= hich was energy. Over the past three decades, there has been a painful unwilling= ness to get real about energy. The debate has been about ozone and greenhouse emissions, not about how to produce enough energy to sustain worldwide grow= th. The discourse has been about making nice: so the Millennium Development Goa= ls signed by one and all, without ever wondering where the energy was going to come from. Initiatives to reduce greenhouse gas emissions, while making nice with the influential anti-nuclear, anti-drilling lobbies. The make-believe = that somehow all-round growth and poverty reduction was possible, energy needs m= et, greenhouse gas emissions reduced. By what strategy, pray? Pretending that w= ind farms (without detracting from scenic views) and assorted renewables would = do the needful; please ignore the arithmetic. Or may be like the New Economy, = New Banking, this was New Energy.

The developing world has to figure out if it wants= to continue to grow and realistically meet its energy needs to sustain that gr= owth. It must recognise that the nice people in the developed world, who genuinely want to reduce poverty and save the Planet, also dislike nuclear technology= and have other objectives that are internally inconsistent, even if they are sincere.

An incurable optimist, I believe that the world wi= ll sort out its problems and will return to faster and more sustainable growth= . Macro fundamentals, particularly price and fiscal balance, will be restored. Hopi= ng however is not good enough: we have to do it. The first order of the day is= to prevent imported inflation to feed on domestic resource tightness and cause= our body economic to be ravaged. The second is to nurture business and consumer confidence, part of which is necessarily about restoring macro fundamentals= to strength. Our financial sector is yet strong, exports are growing and investment continues apace. Things are difficult with the capital markets taking a beating, steeply raising the cost of equity and limiting debt opti= ons, but we will get past all of that, as long as we persevere on a consistent longer term strategy for sustained growth, which has to fundamentally inclu= de expanding our energy options.

(The author is Economic Advisor, ICRA)

[Total number of words excluding title: 1,054]

The Economic Times: Friday, June 27, 2008

<= o:p>