Global Trends by Martin Khor

Monday 21 January  2008

Ghastly week for world economy

With one bad news after another coming from the U.S. and the U.K. economies, the question has changed from whether there will be a recession to how and how much it will affect developing countries like Malaysia.


It was a terrible week for the global economy.  It may become known as the turning point that tipped the balance between hope and fear into an emerging consensus that the United States and some other major economies are entering a recession.

The rest of the world will be caught in the effects.  Whether these will be mere ripples or big waves remain to be seen.

Already Malaysia and other Asian countries have been affected through the decline last week in the stock markets, in line with the falls in the U.S. and European markets.

Share prices at the Kuala Lumpur stock exchange went through a roller coaster ride.  The KLSE index soared to break the 1500 level on 11 January and went on to a historic peak of 1524 during last Monday, before sliding after that to 1439 at the close of trading on Friday.

The news coming from Singapore is especially bad.  Non-oil domestic exports fell by 4.5% in December from a year earlier after a 3.4% drop in November, indicating the island state will be hard hit by the US slowdown.

In his column in The Star last Saturday, Seah Chiang Nee painted a vivid story of Singapore consumers caught by high prices and a painful stock market decline in which many Singaporeans have lost many thousands of dollars.

At the start of the new year, the question was whether the US would have a soft landing or an outright recession.  Now that the recession is imminent, or may have already begun, the question has shifted to how well or badly other countries will weather it.

In Malaysia there is still a fair bit of optimism.  A slowdown in exports to the US can be offset by several factors including a very good performance in commodities (palm oil and petroleum prices are at all-time high levels), the expected continuing high growth in the Asian region (especially China and India) and the engines of domestic growth (including from government spending).

Bank Negara Governor Tan Sri Dr Zeti Akhtar Aziz last week, while in Hong Kong, predicted 6% growth for the Malaysian economy in 2008, which can be considered high compared to other countries in a recession-laden world.

“Right now our economy is still on a steady growth path and we envisage this to continue in 2008 because of our strong domestic demand and strong inter-linkages with other Asian economies that are doing well despite the difficult environment,” she said.

The Malaysian Institute for Economic Research has also forecast 5.4% growth for Malaysia this year on the assumption the US recession would last two quarters.  But if the recession is deep and longer the forecast for Malaysian growth would have to be revised to 4 to 5 per cent.

A growth rate of 4 to 6 per cent can be considered decent and optimistic, given the endless series of bad news coming from the US and other countries such as the United Kingdom.

”This was the week when any lingering hope that the US and UK might somehow muddle through the crisis that has engulfed the international capital markets without undue damage to the underlying economy finally seemed to evaporate,” wrote business editor Jeremy Warner in The Independent of 19 January.

”Can we still hope for just a mild downturn, or will it be one of the big, searing ones like those of the 1970s and early 1990s? One thing seems certain: outright recession – with job losses, bankruptcies and home repossessions surging – looks a lot more probable this weekend than it did just seven days ago. It is hard to recall a week of such concentrated negative economic news.”

Among the bad news were the US$9.8 billion fourth-quarter loss by Citigroup and massive write downs by several of the biggest banks, as well as a deterioration in data on unemployment, retail sales and manufacturing.

The much-maligned “sovereign wealth funds” of developing countries which only weeks ago were seen as threats to Western companies have suddenly turned out to be the saviors of the Western financial system.

The “sovereign funds” of Singapore and Kuwait are the main contributors to the US$12.5 billion capital infusion to Citigroup announced last week, in addition to an injection of US$7.5 billion from Au Dhabi in November.

Singapore and a Middle East investor pumped US$11.5 billion into the Swiss bank UBS.  China’s investment corporation will invest US$5 billion or 9.9% of the shares in Morgan Stanley.  Singapore’s GIC and China’s Development Bank were invited by Barclay to inject US$11.5 billion equity.

The Western governments are now probably grateful that the cash-rich government investment funds of the developing countries have infused so many billions of dollars to rescue the battered banks.  This saves the governments of these banks from having to do the job themselves, thus sparing them from being accused by their own public of molly-coddling and subsidizing the giant banks.

In future, however, we can expect the Western governments or their public to accuse these “sovereign wealth funds” of taking advantage of the crisis to buy into such significant stakes in some of the largest banks in the world.

Meanwhile a credit crunch seems to be developing, that will deepen recessionary tendencies.  A Reuters report last Friday said that US banks, stung by billions of dollars of bad debts are raising lending standards, making borrowing costlier for consumers anf companies.

“It’s a vicious cycle,” Ray Soifer, chair of a bank consulting firm, was quoted by Reuters as saying.  “As banks tighten up lending standards, credit is harder to get, which is worse for the economy, which makes banks tighten up more.”

The U.S. Federal Reserve is expected to make more cuts to the interest rate.  But several economists are warning that there will be limited positive effects on the economy from these cuts, and that a recession is on the cards.