In the past month, financial markets have started to realise that the credit crunch is so much more than just a finance sector event.
It is also having a significant impact on economic growth and employment. The only question now is how deep the recession will be and how long it will last.
Economists in both the private and public sectors (namely central banks) recently revised down their growth forecasts for gross domestic product and employment for the remainder of this year and on into 2009 and 2010.
Just last week, the International Monetary Fund knocked the best part of a percentage point off developed market and emerging market growth for 2009. Developed markets are now expected to contract next year, the first contraction since World War II.
Emerging markets are expected to grow at just over 5 per cent next year. Combined, that leaves global growth for 2009 at a dismal 2.2 per cent.
The IMF's previous forecasts were prepared in October. One percentage point is a tremendous amount of expected growth to lose in just a month.
We agree with the IMF that developed markets will suffer most in the short term and that recovery will be slow as many households have to pay off debt to get their balance sheets back in order. We believe many forecasters are too sanguine about the expected timing and strength of the developed market recovery when it comes. This will not be a V-shaped recovery.
On the other hand, emerging markets will get hit hard in the short term as exports decline but are likely to recover more quickly. Emerging markets do not have over-leveraging to contend with and have the positive dynamic of quickly growing urban populations.
As for New Zealand, we know all about recession because we've been in one all year. Over- leveraged households in an environment of declining house prices are putting a damper on consumption.
Lay the global situation on top of that and the recovery we might have expected to see early next year is now pushed out a further 12 months, meaning 2009 will be weak. That's despite a lower exchange rate, lower interest rates, lower petrol prices and a significant easing in fiscal policy.
We don't see New Zealand back to anything remotely like trend growth until late 2010 or early 2011.
The longer-term issues underpinning economic growth are still the same as they were last month, last year and even 10 years ago: the strength of our innovation system, our ability to commercialise those innovations, the quality of our regulatory framework, our ability to remove infrastructure bottlenecks, how well we invest in skills and the strength and depth of our capital markets.
These are still the fundamental issues we need to focus on if we're really serious about building higher sustainable growth in New Zealand.
The complicating factor will be access to credit. One of the persisting effects of the credit crunch will be tighter and more expensive credit conditions. This will have important implications for households, businesses and indeed countries which have tended to consume more than they produce and run persistently large balance- of-payments deficits.
However, that's not all that's going to be different. The deleveraging dynamic in developed markets is one that may take some years to fully play out.
Potentially, this means a long period of sub-trend growth in developed markets. Consequently, we, as fund managers, have to think carefully about where the best returns will come from over the next few years.
The days of economic cycles being driven by cheap credit and consumption are well and truly over. Growth will be driven by the productive sectors of the world's economies. While that will be hard work in the short term, that sort of growth may prove to be more enduring.
Longer term, we believe there is going to be an acceleration in the rebalancing of global growth, wealth and political influence toward emerging markets.
* Bevan Graham is chief economist at Arcus Investment Management, a member of the global AXA group.
- © Fairfax NZ News
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