December 2009

Where’s the growth?

Recent economic growth data have confirmed that many of the world's major economies are emerging from recession. But analysts remain divided as to whether the ongoing recovery will forge ahead or be "double-dipped", in which a nascent recovery peters out before sliding back into recession. The next few quarters are likely to end the debate one way or another.

With unemployment far from peaking, the outlook for consumption is not sanguine. In the continued fallout from last year’s financial crisis, many business sectors are undergoing wholesale restructuring, which will inevitably result in additional job losses. The psychology of job insecurity is likely to hamper consumer spending going forward: despite the best efforts of governments and central banks to stimulate consumption (record-low interest rates, tax initiatives, quantitative easing etc.), many consumers will nevertheless be inclined to save, even though the financial reward for doing so is paltry.

Smoke and mirrors
Investors should also not be misled by the superficial quality of corporate earnings, especially as the year-on-year result comparisons are calculated from a very low base. Earnings have generally been better than anticipated, although, in many instances, this is largely due to depressed expectations or cost-cutting. Cutting costs can add to a company’s bottom line, but this does not imply sustainable future growth (in contrast with a real increase in sales) and often involves headcount reduction, thus compounding the unemployment/consumption conundrum.

The huge stimulus packages that the authorities have thrown at the growth problem have so far made little impression on final demand. One reason for this, in addition to employment insecurity, is that the banks have not transferred the cheap liquidity provided in abundance by the central banks to those that need it most: households (especially mortgage owners) and small and medium-sized businesses. The banks are understandably risk-averse after having their fingers badly burnt last year, but, even at those banks willing to supply credit, the margins demanded for any prospective loans are excessive, in consideration of the current interest-rate backdrop, and represent a disincentive to potential borrowers, thus undermining the intention of the authorities’ measures.

Risk and reward
Perversely, their supposed risk aversion has not prevented certain banks (some of whom continue to require government funding to survive) from financing high-risk transactions that have enabled them to pay the huge bonuses now back in the headlines, with no apparent fear of a social, political or regulatory backlash. Such activities, however, have been accommodated by the extraordinarily low level of interest rates – a situation that cannot persist indefinitely. And, if banks are not lending at prevailing interest-rate levels, they are unlikely to do so once rates eventually rise.

For sustainable growth to ensue, consumer behaviour must be galvanised into action. The policies to engender this development are in place, but are not being implemented practically. Unless action is taken to enforce higher lending levels, many national economies, having now arguably overcome the worst effects of the financial crisis, may simply drift, but the risk of slipping back into recession will remain very real as long as lending inertia persists.