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Do policymakers have the room to act?

Publication Date : 29-06-2012


One persistent myth in this current financial crisis is that Greece has gone through years of austerity.

Actually, from 2008 to 2011, the Greek government ran a budget deficit that averaged more than 11 per cent of its gross domestic product (GDP, a measure of total economic output) per year. If Thailand had a budget deficit of 11 per cent of GDP per year for the past four years, the government would have had around 3 trillion baht (US$94.04 billion) more money to spend. That is the opposite of austerity - it would be overwhelmingly the largest stimulus package in Thai history.

The normal policy response to tough economic times is for the government to run large budget deficits to stimulate growth. But this presupposes that, during good times, the government had been saving money. That has not been the case for Greece. Now, with its economy weaker than ever, debt levels are so high that markets are not willing to lend Greece any more money. This has led to lots of drama about the Greek default and bail-out negotiations.

The key lesson is that overly aggressive policies in the past can give countries little to manoeuvre in the present.

This line of thinking is also why the Federal Reserve (the central bank of the United States) disappointed some investors by not announcing a third round of quantitative easing (the so-called QE3) at its meeting on June 20.

Economic figures from the US have been disappointing, and markets had been half hoping that authorities would respond with an aggressive monetary expansion. However, the Fed decided to keep this option for another day, and implemented a much more moderate policy.

An aggressive QE3 programme would have been negative for the US dollar due to the large increase in money supply. It would have been a boost for other major currencies, as well as hard commodities such as gold. Shifting expectations on the Fed's policy have therefore caused volatility in many financial markets.

The importance of having policy flexibility is also the reason why economic prospects in China still appear reasonable.

There have been worries about China's slowing economy. Industrial production growth is at close to a three-year low. Well-regarded activity indicators (such as purchasing managers' index surveys) have been showing weaknesses for many months.

There are also many scary anecdotal reports. Empty housing estates created by over-optimistic developers. Mountains of excess coal, no longer needed due to declining electricity generation. Too much borrowing by local government entities.

But is the Chinese economy headed for a crash? The answer is no.

Chinese authorities have already announced several measures to fight the slowdown. The central bank has cut the reserve requirement ratio for banks thrice since December, to promote lending growth. It has also just cut interest rates for the first time since 2008. Additionally, the government is speeding up approvals on infrastructure projects and offering new tax incentives.

Importantly, the government has the ability to do more. Inflation is below the 4 per cent target, and seems likely to fall further. This will allow further cuts in interest rates and the reserve requirement ratio.

The Chinese government's finances are in sound shape, with low debt and rising revenues (up 13 per cent in the first five months of 2012, to give the government around 3 trillion yuan in cash reserves). This gives plenty of space for the government to implement direct spending measures or tax cuts.

Hence, despite some weaknesses in the first half of the year, HSBC Research still expects 2012 GDP growth in China to be a robust 8.4 per cent.

This is important for Thailand too. The euro zone will almost certainly be in recession in 2012, but the Thai economy's direct dependence on Europe's weaker economies (whether in terms of exports, investments, or tourism) is small. The bigger question is whether or not Europe's crisis will lead to a global recession, similar to what happened in late 2008 after the Lehman Brothers debacle in the United States.

To that end, China (which is Thailand's largest single export destination) will be a key variable going forward. If China avoids a crash, and if it is able to grow more strongly in the second half of the year, that would be beneficial for other economies as well.

Parson Singha is chief markets strategist in the Global Markets Dept at HSBC Thailand.


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